RBI policy: Even a rate cut by Raghuram Rajan may not benefit the common man

Unlike the previous occasions, this time around, there is a clear absence of consensus among senior economists with respect to what Raghuram Rajan would do when the monetary policy is unveiled on Tuesday. Some, such as Rajeev Malik of CLSA and D K Joshi of Crisil  believe that the central bank will go for the third rate cut of this year, in the face of anemic growth and easing inflation. The other camp, including Sajjid Chinoy of JP Morgan pitch for a status-quo on Tuesday citing uptrend in consumer price inflation in recent months, which could force RBI to put off the rate action to later part of the year. Retail inflation rose to 5.37 per cent in February, from 5.19 per cent in the previous month. What Rajan would ultimately do is a mystery that often defies the market logic. Time and again, the former International Monetary Fund (IMF) economist has demonstrated his ability to surprise the markets with unexpected moves, including off-policy-date actions. For the common man on the street, none of this, however, matters until his bank cuts interest rate on his home or auto loans. And, unfortunately, reasons that favour cut in lending rates have been largely absent and outside the control of monetary policy. The biggest evidence for this is that even a a 50 basis points (bps) cut in key rates by RBI since January, hasn’t, evidently, resulted in the banker to slash loan rates. One bps is one hundredth of a percentage point. This is when most banks have begun cutting their deposit rates since October, which should have technically followed a cut in lending rates cuts since banks calculate their base rate also considering their deposit rates. But that hasn’t happened yet. Reason: Factors that prevented banks from lowering their loan rates have remained quite strong. These include piling up of bad and restructured loans, weak earnings growth and poor capital position of state-run banks. [caption id=“attachment_2155835” align=“alignleft” width=“380”]  RBI Governor Raghuram Rajan. PTI[/caption] Banks wanted to repair their balance sheets by cutting down bad debt, before further expanding their loan book, by attracting fresh borrowers offering cheaper loan rates. Secondly, high provisions on bad loans and low demand for loans have put pressure on their earnings and any significant cut in lending rates at this stage would have worsened the situation. Hence, banks aren’t in a hurry to cut lending rates. Till this point, the risk factors outweigh favorable elements for cut in bank lending rates. To be sure, if RBI cuts repo by a quarter percentage point, some banks would certainly cut lending rates in April but such rate reductions are only likely to be marginal, and hence wouldn’t offer much of a relief to the EMI burden of the borrowers. In the long-term, however, if the economy recovery gets delayed and corporate loan demand remains subdued, banks will have to lower their loan rates to attract good quality corporations, since they run the risk of losing out big companies to corporate bond market, the signs of which have already begun. Even if Rajan opts for a 25 bps rate cut in tomorrow’s monetary policy, it’s not going to make much  difference for banks, since this would give only a marginal relief to banks in lowering their cost of funds. Repo rate, at which RBI lends overnight funds to banks, currently stands at 7.50 percent. Instead, if Rajan opts to cut the cash reserve ratio (CRR) by about half a percentage point, currently at 4 percent, the banking system will get an instant dose of Rs 40,000 crore, which can technically enable a bigger rate cut in lending rates. In the past, the central bank has candidly admitted that its ability to nudge banks to adhere to the monetary policy signals, or the process of monetary transmission, is weak. In the current scenario, where factors influencing banks to tinker with their lending rates are far beyond the central bank’s control, monetary policy is largely a non-event for the common man. It would be unwise to expect significant cut in bank lending rates in the near future.