RBI rate cut not likely to boost corporate lending, private sector's capex

Historically, there has been no correlation between growth in bank credit to industry and lower benchmark interest rate

The recent cut in benchmark interest rate by the Reserve Bank India (RBI) is not likely to boost corporate lending and private sector’s capital expenditure (capex), going by past trends. 

Historically, there is no correlation between growth in bank credit to industry and lower benchmark interest rates. On the contrary, data suggests an inverse relationship, wherein faster growth in corporate lending had occurred during periods of rising interest rate and vice versa.

For example, the benchmark interest rate rose steadily from 4.75 per cent in February 2010 to a high of 8.5 per cent by March 2012, but the period saw a sharp uptick in bank credit to industries. In contrast, benchmark interest rates have been on a downward trajectory for the better part of the last five years but it did little to lift industry credit.

The year-on-year growth in bank credit to industry declined from a high of 30 per cent at the end of December 2010 to record a low of -5.2 per cent in February 2017.

Industry credit recovered in 2018 but it coincided with rise in the benchmark interest rate.

Experts are not surprised. “Cost of capital is only one of the many factors that affect corporate capex. New projects also depend on the growth opportunities available in the economy. Index of Industrial Production (IIP) is on a downward trajectory and capacity utilisation in the manufacturing sector is not improving. This is not a recipe for companies to start investing in new projects,” said Madan Sabnavis, chief economist at CARE Ratings.

Others said the demand conditions are a better driver of investment than the borrowing cost. 

“The aggregate demand has softened in recent months as indicated by the latest trend in automobile sales. Given this, it would be premature to talk about a revival in corporate capex only because the central bank has cut the benchmark interest rates,” said Devendra Pant, chief economist India Ratings & Research.

Others raise the issue of policy transmission. “Transmission of the rate cut to the borrowers is a bigger issue than the headline benchmark interest rate. Lending rates are down by only 20 basis points against 50 basis points cut in the policy rate by the RBI. Besides, liquidity has been tight during the better part of the past 12 months, hitting overall lending activity in the economy,” said Karthik Srinivasan, senior vice-president, ICRA Ratings. One basis point is one-hundredth of a per cent.

Many, however, said that the latest cut in benchmark interest rate by the central bank will benefit corporates and existing borrowers by way of lower outgo on account of interest rates. “If banks and lenders pass on the rate cut to borrowers, it will aid companies profit & loss account by lowering their interest cost,” said Sabnavis.

Its overall impact will, however, be tough to quantify, given the few basis points decline in the overall lending rate. Lower lending rate could also aid household budgets, especially those with high-value home loans.

India Ratings also said that if the lower policy rates translate into lower lending rate, it could lift retail lending on the margins but its overall impact on total private final consumption expenditure is tough to quantify. 

“Past data suggests a weak correlation between lending rate and retail credit or personal loans. Last five years saw a boom in personal loans and it coincided with a steady decline in interest rate. So, the latest move by the RBI could provide a mild boost to retail lending which should aid consumer demand,” said Pant.

However, he added that only retail loans constitute a small part of the overall private final consumption expenditure or PFCE in the economy and it’s tough to quantify its overall impact on the economy and demand growth in various sectors.