HW English
shaktikanta-das
Banking

Why RBI’s rate cut won’t lower your EMI?

The Reserve Bank, in its bi-monthly monetary policy meeting (MPC), cut benchmark interest rates by an unprecedented 35 basis points or 0.35%, which now takes the repo rate (i.e the rate at which the RBI lends money to other banks) to 5.4%. At current levels, the repo rate is the lowest since 2010. Prior to this cut, rates had been reduced three consecutive times this calendar year, each by 25 basis points, and if we include this one, it takes the total quantum of rate cuts in 2019 to 110 basis points or 1.1%. And, add to that the RBI has maintained an accommodative stance, which means that it is willing to cut rates further going forward. That’s indeed a steep rate cutting cycle that the RBI has implemented ever since Shanktikanta Das took the reins at the Central Bank. A conservative economist such as former RBI Governor Urjit Patel might not have agreed with it, but that’s a discussion for another time.

Building up to the meeting, a demand for a rate cut had been made across the spectrum, from politicians in Delhi, to fund managers in Mumbai. It’s no secret that India is the midst of an extreme slowdown, and for those saying it’s a cyclical thing; they couldn’t be more wrong. A combination of stressed macro-economic indicators makes for a disturbing reading.

 

Tough decisions and policy actions to better the situation are not being taken by the government. They just do not seem to be acknowledging the fact that our economy is in the doldrums.

Amid these testing times, the government has no other option but to convince the RBI to cut interest rates in their last ditch attempt to encourage growth.

Another aspect to this is transmission of this rate cut to the final consumer. This means when will our EMI’s (for home loans, vehicle loans, personal loans, term loans etc.) when will they reduce? It’s only when our EMI’s become less, will we be encouraged to borrow more, and in turn spend more, and that’s how the economy will kick start. Transmission of interest rate cuts is where our system has let us down. It is also worth noting that the RBI has flushed the banking system with additional liquidity. So, in spite of having a liquidity surplus of over ₹ 2 trillion and multiple rate cuts affected by the RBI, still lending activity hasn’t improved. Few banks such as SBI and HDFC Bank have passed on minor benefits to their borrowers in the form of reduced rates for fresh loans, but nowhere in the same proportion to how the RBI has cut rates.  It is because the final consumer is not getting access to these reduced rates is what is holding the economy back.

The most important reason why we do not get the benefit of reduced interest rates is because of the borrowing spree the government has embarked on. The more the government borrows, the less is available for the private sector. And, interest rates at the end of the day are a function of demand and supply. This means that if the centre keeps borrowing and exhausting funds available at lower interest rates, others are left to borrow at high rates. How this is done is like this.

The government likes to say that it maintains its fiscal deficit target (which is the difference between its revenue and expenditure). This excess expenditure of the government, over its revenue is met by borrowings. The centre has set a fiscal deficit target of 3.3% of GDP for itself for the year 2019-20. The fact is that the government has not been able to meet this target and has overshot it for past years. A latest report by the CAG (which is the authority that audits the receipts and expenditures of the government) has suggested that the centre has manipulated this figure for F.Y. 2017-18. The government makes public sector enterprises borrow and spend on its behalf. So, the food corporation of India has been made to borrow in excess of ₹ 1 trillion from the market and spend on food security of the country, on behalf of the government, and this is not reflected on the government’s balance sheet. Meanwhile, the Finance Minister comes out and says that we have achieved our fiscal deficit target. Other public sector enterprises have also indulged in such borrowings leading to the fiscal math being manipulated, and worse this increased borrowing by such PSBs has led to crowding out private sector borrowings.

Another reason why banks are finding it difficult to pass on reduced rates is because of deposits. Public deposits are the life blood of banks, especially in developing countries like India. Since competition to accept deposits have risen sharply in the last few years, with new small savings schemes, post office deposits etc. banks cannot reduce their interest rates on such deposits or they will lose business. Hence, interest rates given on deposits (which is an expense for the bank) remains high, and consequently, they have to charge a higher rate on loans given out by them to compensate.

Additionally, banks link their interest rates to their incremental cost of funding via a mechanism known as MCLR or marginal cost of lending, instead of an external benchmark such as RBI repo rate. This results in a much slower transmission of rates, and banks must be encouraged to link them to external benchmarks instead.

Finally, since the economy is in such a depressed state, household savings have fallen. Household savings are the backbone of the economy, in the sense that most of such savings are mobilised into deposits. And the more deposits that banks have, the more they can lend money. So, with total borrowings of the government and PSUs going up, and household savings (which are needed to finance them) falling dramatically, one cannot expect interest rates to fall by much.

 

Related posts

Wilful Defaulters on the rise

News Desk

Yes Bank Stop Misleading

Akhilesh Bhargava

J&K – A Saga of Crimes

Akhilesh Bhargava