Banks, which have been resisting interest rate cuts for some time, are likely to bite the bullet now, with the central bank surprising everyone with a 25-basis-point repo rate cut for the second time in 45 days.
Upbeat on the government’s fiscal consolidation plan announced during the Budget last week, Reserve Bank of India (RBI) Governor Raghuram Rajan cut the interest rate on Wednesday, much ahead of a policy meeting of the central bank on April 7.
“The government intends to compensate for the delay in fiscal consolidation with a commitment to an improvement in the quality of adjustment,” Rajan said. He added with the release of an agreement on a monetary policy framework, it was appropriate for RBI to offer a picture of how it would implement the mandate.
Putting pressure on banks in terms of monetary policy transmission, Jayant Sinha, minister of state for finance, said the rate cut would reduce equated monthly instalments and there was scope for further rate cuts. Rajan also appeared to favour faster response from banks, saying banks appeared to be quicker in raising rates rather than in cutting those. “I have no doubt the pressure of these two rate cuts will, in time, feed into lower rates. We are also examining whether there are any institutional constraints in passing on these rate cuts. The hope is as we move into the next financial year, we will see more transmission into lower interest rates,” he said.
Following the repo rate cut in January, only three banks had reduced their base rates. This time, however, some large lenders are likely to cut their lending rates, as deposit rates have been falling.
V R Iyer, chairperson and managing director of Bank of India, said the state-run lender would cut its base and deposit rates soon.
“The ALCO (asset liability committee) will meet in a day or two. We will reciprocate RBI’s action and the Budget announcements supporting growth. The liquidity is comfortable. So, we can reduce deposit rates,” Iyer said, adding though demand for credit continued to remain weak, she expected it to improve after two quarters.
“Our bank will take an appropriate call of a cut in base rate by looking at all evolving circumstances,” said Arundhati Bhattacharya, chairman of State Bank of India.
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Rakesh Sethi, chairman and managing director of Allahabad Bank, said the bank’s ALCO would meet on Thursday to explore the possibility of a lending rate cut. “A decision (on a base rate cut) will be taken by the ALCO. In January, we did not reduce our base rate because our cost of deposits was unchanged. For lending rates to fall, deposit costs need to come down,” he added.
Banks have been refraining from cutting lending rates due to weaker margins amid sluggish loan growth and rising bad loans, which reduce interest earning. In April 2014- February 2015, bank loans grew only 7.5 per cent, the slowest in about a decade.
Market participants said there would be more rate cuts, as Consumer Price Index-inflation was expected to stay much below the six per cent target for January 2016, according to the new monetary policy framework agreement.
“We believe the inflation trajectory will be key to the magnitude of rate cuts. The inflation outlook and the real rate policy framework followed by RBI means the central bank will cut the rate by an additional 100 basis points though 2015, with the next move happening during the April 7 meeting,” said Chetan Ahya and Upasana Chachra of Morgan Stanley Research, Asia Pacific.
In his statement, the RBI governor said, “Given the low capacity utilisation and still-weak indicators of production and credit off-take, it is appropriate for the Reserve Bank to be pre-emptive in its policy action.” While he acknowledged an improvement in the economy, Rajan doubted whether it was doing as well as official gross domestic product data suggested. Following recent changes to the methodology used to compute the data, it was seen at 7.5 per cent, India’s growth had outpaced China’s in the December quarter. “Nevertheless, the picture of a steadily recovering economy appears right,” he said.
At a conference call with analysts, Rajan said RBI would target inflation of four per cent by the end of January 2018, adding a real interest rate of 1.5-2 per cent was appropriate at this point. Bond markets reacted strongly to the RBI move, with the yield on the 10-year benchmark bond closing six basis points lower than its previous close.