 "Futility of a rate cut")
Before the Reserve Bank of India (RBI) announced its mid quarter review, demand for lowering of interest rate were based on the rationale of a decade low Gross Domestic Product (GDP), core inflation below 4% and falling consumer demand across all consumables. RBI did oblige by cutting down key repo rates by 0.25%.
Markets, however, did not appreciate the cut as much as was expected, primarily because of the hawkish undertone in delivering this rate cut. RBI has made it clear the interest rates in the near term will remain unchanged. The market is now deprived of fuel for its move higher.
Along with the market, the economy too has not benefitted much from the 25 bps cut. Banks have declined to reduce interest rates, not because they don’t want to but because they cannot afford it. In order to maintain their net interest margins, banks would have had to reduce their cost of borrowing too, if they would have lowered interest rates to its customers. Given the declining pace of deposit mobilisation, banks would have found it even more difficult to access funds, especially in the present tight liquidity scenario.
The current politico-economic environment is preventing banks from lending money to corporate, which it believes is a riskier business. Banks rather prefer to deploy their cash in government bond. Till this dichotomy is not changed, RBI reducing rates is unlikely to help both the markets and the economy.
Markets, however, did not appreciate the cut as much as was expected, primarily because of the hawkish undertone in delivering this rate cut. RBI has made it clear the interest rates in the near term will remain unchanged. The market is now deprived of fuel for its move higher.
Along with the market, the economy too has not benefitted much from the 25 bps cut. Banks have declined to reduce interest rates, not because they don’t want to but because they cannot afford it. In order to maintain their net interest margins, banks would have had to reduce their cost of borrowing too, if they would have lowered interest rates to its customers. Given the declining pace of deposit mobilisation, banks would have found it even more difficult to access funds, especially in the present tight liquidity scenario.
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With interest rates out of the picture, the key number coming out of the RBI which needs to be closely watched in non-food credit growth. Apart from agriculture credit growth has slowed down for all other sectors. Non-food credit growth stood at 14.6% in January 2013 compared to 15.9% in the previous year. Deposit growth on the other hand was 200 bps lower. Credit to industry grew by 15.2% in January 2013 as against 20.2% last year.
The current politico-economic environment is preventing banks from lending money to corporate, which it believes is a riskier business. Banks rather prefer to deploy their cash in government bond. Till this dichotomy is not changed, RBI reducing rates is unlikely to help both the markets and the economy.