Interest rate lobby should prod Jaitley to refuel banks; an RBI cut is useless otherwise

A further cut in the Reserve Bank of India (RBI)’s key lending rate, repo rate, is a high probability in the 2 June policy review or even before that considering the threat emerging from inflation, both on wholesale and retail prices, is practically non-existent now. The wholesale price-based inflation (WPI) fell to (-)2.65 percent in April, marking the sixth consecutive month of decline, following a fall in retail inflation to 4.87 percent in April. This has added fuel to speculation the central bank would go for a third round of rate cut this year, after two surprise cuts totalling 50 basis points so far this year. As noted before , falling inflation and anaemic economic growth indeed offer enough reasons for the common man to expect a rate cut. The high frequency macro-data doesn’t suggest any signs of strong revival in economy. Corporate earnings are hit both by poor demand and lack of fresh investments. [caption id=“attachment_2246594” align=“alignleft” width=“380”] Arun Jaitley should take steps to fund banks before RBI cuts rate again[/caption] Also, if one looks at the previous RBI policy statement, indeed there is progress on two main conditions sought by governor Raghuram Rajan for future rate cuts - reduction in bank lending rates and further easing of inflation. Thus, growth, more than inflation, should top the priority of the central bank at this stage. But, would another RBI rate cut mean any relief to the end-consumer? Most likely not. Most banks had cut their base rates or minimum lending rates by a quarter of a percentage point in the last few weeks taking the base rates to an average 10 percent. But one should note that banks have passed on only part of the RBI rate cuts so far. Banks are unlikely to go for one more round of rate cut in the near future given the stress on their interest margins. A glance at the bank earnings in January-March shows that majority of them have logged a drop in their net interest margins. “It is doubtful whether bank lending rates would be cut further. There doesn’t seem to be any more room for that,” said the chairman of a Maharashtra-based state-run bank. If banks do not pass on rates, that would make RBI policy a non-event. Any rate cut in the central bank’s key rates doesn’t mean much for the individual or corporate borrower unless the rate reductions are passed on to the end-consumer. The banking sector, mainly state-run banks, is also constrained with the severe capital shortage after the government sharply cut down capital support, limiting their ability to expand their loan books further. It would make more sense for the industry lobbies, the corporates campaigning at the RBI’s doors, to first prod finance minister Arun Jaitley to make capital available for state-run banks, which constitute 70 percent of the banking system. Unless banks are equipped with funds, rate cut is of no use. (Data support from Kishor Kadam)