The market is always abuzz with the news or expectations of a rate cut, to the extent that it has become a habit. Earlier there would be such expectations 8 times a year, which has reduced to 6 times now. Further, given that the RBI has also gone in for such cuts in between policies, there are similar signs in the market after an event like the budget or even the release of inflation data on the 12th of the month. It is not surprising that there are again expectations of a rate cut in the policy to be presented on the 5th of April.
There are several questions around this issue. First, why are expectations so high besides the ‘habit’ factor? It may be recollected that the RBI in its earlier policy had mentioned that it had not touched rates, as a critical bit of information that was still missing was the Union Budget and its impact on the borrowing programme of the government and hence liquidity in the system. The FM delivered adequately on this count and presented numbers that keeps borrowings under control as we tread on the path of the FRBM. In fact, there was a not-so-subtle indication given by the government that the RBI had to supplement its own efforts from hereon.
Second, is there any other signal that leads us to believe that there will be a cut in the repo rate? Here again quite strategically the government has plugged another leakage in the transmission system by way of returns on small savings. By lowering the rates across the small savings spectrum the government has once again told the RBI that it is time to lower the rates. There is a close relationship between repo rate, the GSec rate, the deposit rate and the base rate. The lower small savings rate has caused GSec yields to drop which in turn calls for lower repo rates which will be followed by banks lowering their deposit and lending rates.
Third, what is the RBI’s stated goal on interest rate policy? Was not it something different? The answer is yes, as the CPI inflation number was the stated goal and the latest data shows that there has been a single month dip in this rate. It is a matter of conjecture whether the RBI will interpret this single number as a strong enough sign to lower interest rates given that there could be a spike in case the rabi crops get affected due to the unseasonal rains. Besides, inflation is still above 5% and while it is within its medium term range, it is again a guess whether it can be a trigger.
Fourth, by how much will the RBI cut the rates? The markets are crazy and hence the answer is now gearing towards aggression. A week back, such a question would have had a response of 50 bps for the entire year. But now the euphoria in the market indicates to 50 bps cut in the April policy with nothing less going to be acceptable. In fact the stock market has taken heart at the small savings rates reduction as well as the declining bond yields, and the enthusiasm will be dented seriously if there is anything less than 50 bps cut.
Fifth, will a further rate cut lead to lower lending rates? A shoulder shrug is the best answer as lower repo rates in the past has led to lower deposit rates but not necessarily lower lending rates. Also lending rates come down gradually even while deposit rates see a sharp drop. The reason is that all outstanding credit gets re-priced at lower rate while only incremental deposits are priced at the new interest rates. Therefore, we cannot expect a commensurate decline in lending rates even if repo rate is lowered by 50 bps and deposit rates by an equivalent amount.
Sixth, will lending increase? Here the answer is more certain as we have seen that over the last year, lower rates do not translate into an increase in credit. While retail credit does receive some boost especially on the housing side, corporate loans remain stuck as they are linked with demand conditions, which are lackluster presently with surplus capacity in almost all industries. Infra lending is possible but given that projects have not taken up in a big way, demand for credit is low. Last, the current problem of NPAs will make banks more risk averse and they would tend to still keep high premiums above the base rate when lending to corporates.
Therefore, the view is that interest rates will be lowered even though it may not be totally in line with the monetary policy benchmarks set by the RBI – because if this was the case, it could have been done earlier too. The amount could be between 25-50 bps this time though going by the past trends 25 bps would be more likely.
This said it is unlikely that there will be any major pick-up in growth in bank credit considering that it would be the slack season. Also there do not appear to be any major growth impulses in the economy right now with the government being the main driver today. But the markets will be placated. Households however have to bear the brunt of lower interest rates on their deposits and with the small savings route also being made thinner, there would be few options. Maybe the stock market and gold would be relatively more attractive in this situation.
The writer is a Chief Economist with CARE Ratings, and his views are personal.