RBI likely to cut repo rate by 75 bps: Who will benefit the most?
In February 2019 policy, Das along with MPC members decided to cut policy repo rate by 25 basis points to 6.25% from previous 6.50%.
The Reserve Bank of India (RBI) is once again at center stage, as less than a week is left for the first monetary policy announcement of fiscal year FY20. RBI, under governor Shaktikanta Das reign, has made various changes This time, RBI has decided to begin the monetary policy meetings from April 02, and make the final announcement on April 04. Now as days pass by, expectations have risen in terms of policy repo rate cut. This is because inflation indicators have been well placed within RBI’s target, making further room for rate cut. But interestingly, in FY20, it is now being predicted that RBI has opportunity to make 75 basis points cut in repo rate. If this the case, then impact will be seen on common men as well. However, not many are aware, who exactly benefits when RBI decides to follow a rate cut in its policy repo rate. Let’s find out!
Data compiled by State Bank of India (SBI) showed that, domestic demand conditions now looks increasingly weak and fragile.
For instance, household savings in gross domestic savings have been a major concern over the years, as they have been declining significantly. In FY18, the household saving came in at 56.3% from the level of 68.2% which was seen in FY12.
Dr. Soumya Kanti Ghosh, Group Chief Economic Adviser, State Bank of India says, “This trend is disturbing and need to be reversed. One of the possible reason of such decline may be increase in real household debt, as interest rates have not declined commensurately.”
Notably, RBI is an inflation trajectory central bank and hence their policy stance for India, revolves around the movement in Consumer Price Index (CPI) inflation.
In latest month of February 2019, CPI inflation has risen slightly to 2.57% compared to 1.97% in January 2019, but way lower as against to 4.44% a year ago same month. Meanwhile, food deflation narrowed to -0.66% in February 2019, compared to -2.24% from previous month.
Ghosh says, “Our inflation forecasts are much lower than RBI forecasts. For FY20 also we believe that RBI projections are approximately 30 bps more than SBI projections. As per our projections (and as well as of RBI’s also) average CPI inflation in FY20 will stay comfortably anchored at below 4%.”
Apart from this, according to SBI, urban demand is also worrying. Even February sales for the auto industry declined to a new low as weak consumer demand continues into sixth straight month. Investment scenario, as can be referred from orders inflows has declined in Q3FY19 by 20%. NBFCs with higher exposure to SMEs/ Loan against shares and developer loans are likely to see pain in FY20 also. Credit growth is not broad based and is in selective areas only. Capex led growth from listed companies will remain muted and working capital will remain key to credit growth.
Thus, Ghosh says, “We thus expect at least a 25 bps rate cut in April policy (cumulative 50-75 bps over next 2/3 policies) though we believe the stage is ripe for a larger rate cut. If the rate cut is of 25 bps only, then RBI could indicate more cuts through a possible shift in stance/ policy statement. RBI should also take a holistic approach with liquidity framework as call rates are liquidity agnostic.”
Who will benefit?
Any change in repo rate cut, there is a significant impact on citizens borrowings and savings. However, rate cut is joyful moment for banks, and slightly to borrowers but not for depositors. When RBI decides to trim policy repo rate that, funds from central bank become cheaper for banks. This means bank’s raw material becomes less costly, hence, this has a instant reaction on deposits.
For banks - deposits are a liability, as they are liable to pay interest rates to citizens on their investments with them. On the other hand, loans are an asset to banks, because they receive interest including principal amount for the money they lend citizens. Banks do utilize deposits money to lend other borrowers.
Repo rate is at which RBI charges scheduled commercial banks (SCB) for borrowing with them. Banks generally increase and decrease their loans rate for individual, depending upon their borrowing of funds from RBI. If RBI makes repo rate cheap for banks, then the lenders will also make your loans rates cheap. The same is vice versa in rising repo rate.
A very interesting pattern of banks during rate cut is that, they react faster in reducing deposit interest rates, meantime, become reluctant in reducing their lending rates. However, this has changed, and it is quite clear that a borrower enjoys rate cut dilemma, while depositors tend to be losers here. In case of repo rate hike, it is depositors who earn more interest rates.
SBI has linked their savings deposit account above Rs 1 lakh balance with policy repo rate. Currently, SBI has pegged its interest rates above Rs 1 lakh deposits at 3.50% which is lower by 2.75% compared to repo rate. Meantime, HDFC Bank has linked their savings account with balance above Rs 500 crore with repo rate + 0.02%. This means at HDFC Bank, a customer enjoys 6.25% + 0.02% = 6.27% interest rates.
Let’s assume there is a rate cut of 25 bps in repo rate in April 2019 policy, then SBI and HDFC Bank’s saving deposits would come down by the same cut. At SBI, savings deposits interest rate will become 3.25% above Rs 1 lakh, and HDFC Bank’s this investment scheme will see 6.02% interest rate ahead.
Meanwhile, SBI has now kept all cash credit accounts and overdrafts with limits above Rs 1 lakh linked with repo rate 6.25% with a spread of 2.25%. This would mean now borrowers who seek such loans will see a 8.50% interest rate. Here’s if repo rate comes down by 25 bps, then interest rates on short term loan will come at 8.25%.
But it is not necessary that, the bank will immediately make the changes in deposit and lending interest rates in midst of rate cut. It also depends upon monopoly power in banking system like major lenders, they will not be under pressure to pass on lower costs to citizens. Apart from this, banks also have to maintain a gap between lending and deposit rates, and still make the latter look attractive in a scenario where government’s small saving schemes have gained popularity.
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Currently, the scenario is that, banking system’s credit growth has come at 12.9% outpacing deposit growth which recorded growth of 9.3% on yearly basis.
India Rating believes that, if credit growth continues to outpace deposit growth, then scheduled commercial banks reliance on bulk deposits is likely to increase which could lead to a higher cost of funds along with increasing volatility in the asset-liability structure of banks.
Earlier SBI research note highlighted that, gap between small saving schemes interest rate (average of PPF and Sukanya Samridhi accounts rate) and average bank term deposit (>1 year) still remains around 98 bps.
SBI explains, that this has made it difficult for banks to reduce deposit rates. Interestingly, in the last few months, with bank deposit growth significantly lagging bank credit growth, banks have been increasing deposit rates to protect the possibility of deposit flight from banks.
Hence, it would quite interesting to watch on how banks deposit and lending interest rate move in midst of rate cut ahead. Also, can a bank bear increasing deposit interest rate is one big question. In February 2019 policy, Das along with MPC members decided to cut policy repo rate by 25 basis points to 6.25% from previous 6.50%.
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