The Front-End Of Lending: Why Exactly Are Banks Not Catching Up With RBI’s Rate Cuts?

Maintenance of status quo in benchmark rates by Reserve Bank of India (RBI) in its fifth bimonthly monetary policy review, heralds yet another turning point in the rate cycle. Hence, repo rate remains at 5.15 per cent, cash reserve ratio (CRR) at 4 per cent and statutory liquidity ratio (SLR) at 18.5 per cent.

The focus has now shifted to continue the accommodative stance of monetary policy and work towards optimum transmission of policy rates. As against the cumulative rate cut of 135 basis points (bps) front-loaded since February 2019 to October 2019, banks’ marginal cost of funds based lending rates (MCLR) — the minimum interest rate of a bank below which it cannot lend — are down by only 49 bps because the cost of resources of banks are not necessarily impacted by repo rates.

The bulk of liquidity of banks is linked to cost of deposits and not cost of borrowings from RBI.

However, the repo rate cut definitely works as a psychological comfort that can potentially prompt revival of investment, increase in capex, capacity utilisation by manufacturing units and appetite for borrowing.

The interest rate transmission has been better reflected in debt/securities markets while the average overnight call money dropped by 218 bps indicating ample liquidity.

1. Languishing Credit Growth

Given the deepening slowdown of the economy, traditional monetary tools did not prove as effective as was expected. Bank credit growth continue to dither in single digit, incremental rise in deposits too are low with more of pubic savings flowing to post offices.

Lack of appetite of corporate sector to expand, weak investment sentiments, deteriorating employment potentiality and protracted contraction in industrial production along with looming headwinds of inflation and other dampeners have squeezed household consumption, exacerbating the economic woes.

Even linking of lending rates to external benchmark — repo rate for retail and MSME sector did not bring down rates significantly as rising credit risk perception of borrowers, lingering asset quality woes neutralised its impact.

Hence, cost of credit continues to remain elevated.

2. External Sector

Even in the midst of continuing geopolitical uncertainties, it is encouraging that the sentiments in external sector are supportive. The crude oil prices moved in a narrow range amid softer US-China trade talks, likely Brexit deal in the offing and emerging markets turning better.

The US economy has improved in the third quarter on strong private investment while Euro region remained stable. Among the emerging economies, GDP of China is decelerating — with surge in net disbursals of external commercial borrowings to $11.5 billion during April-October 2019 as against $1.2 billion during the same period a year ago.

As a result, India’s foreign exchange reserves climbed to $451.7 billion on 3 December 2019 — an increase of $38.8 billion over end-March 2019. With S&P reaffirming sovereign rating of India, retaining rating as ‘stable’ at ‘BBB–’, there could be better overseas confidence to attracting overseas investments.

Taking such external sector cues and with industrial growth bottomed out, the domestic economy should start revival beginning next fiscal evident from RBI perception.

3. Outlook Of RBI

Coming to domestic sector outlook, having recorded a 4.5 per cent gross domestic product (GDP) growth and gross value added (GVA) clocking 4.3 per cent in the second quarter (Q2) of financial year 2020 (FY20), RBI revised its GDP outlook downwards from 6.1 per cent in the October 2019 policy to 5 per cent now — 4.9-5.5 per cent in (second half) H2 and 5.9-6.3 per cent for H1: 2020-21.

It expects economic revival to manifest beginning in FY 2020-2021 with repeat doses of economic stimulus and relief packages already operationalised. With retail inflation in the month of October climbing to a 16-month high of 4.62 per cent due to elevated food prices, RBI too raised its CPI-led inflation expectations to 5.1-4.7 per cent for H2: 2019-2020 and 4-3.8 per cent for H1: 2020-21, with risks broadly balanced but is still contained within the inflation glide path +/-2 per cent over 4 per cent to range between 2 per cent and 6 per cent.

Encouraged by the growth in public administration, defence and other services that accelerated in line with the surge in government final consumption expenditure, early signs of revival are on the horizon.

Agricultural GVA growth increased marginally, despite contraction in kharif food grains production in the first advance estimates.

Despite unseasonal rains, rabi sowing is catching up and storage in major reservoirs, the main source of irrigation during the rabi season, was at 86 per cent of the full reservoir level as on 28 November as compared with 61 per cent in the same period a year ago.

Though many of the RBI surveys emit continuing decelerating trends, the stakeholders should work towards inclusive approach in reviving growth sentiments picking up positive headwinds from the purchasing managers’ index (PMI) for manufacturing that increased from 50.6 in October to 51.2 in November 2019, driven up by an increase in new orders and output.

It is necessary to desist from continuing pessimism so that the economy at the bottom of the pyramid is able to exude confidence to tread the growth path and restart economic activities that considerably slowed after demonetisation.

At the same time, RBI having sufficiently front-loaded repo rate cuts, the onus is now shifted to banks to come out of the abyss and pass on the benefit of softer rates to trade and industry.

More than the lending rates, uptick in credit off-take will be a critical factor to lend support to trade and industry. Using interest rate subvention provided to MSME sector and given the surplus liquidity, banks should start lending to continue its predominant role in resurrecting the economy.