Economic Survey: The transmission conundrum

The Economic Survey points to incomplete transmission of the monetary policy as one of the factors for sluggish growth of bank credit. This is because banks have not passed on the entire benefit of repo rate cut (the rate at which banks borrow from RBI) to borrowers.

It adds that while policy rates have been reduced substantially with four rate cuts of 125 basis points in 2015, bank lending rates have only fallen by around 50 basis points. However bankers have clarified in the past that it is not that they are reluctant to cut rates, instead they are only waiting for the cost of funds to come down which happens with a lag effect.

Data from the Survey shows that the gaps between policy rates and bank rates have increased significantly over the past year. For example, deposit rates before the first rate cut were about 50 basis points higher than the policy rate, whereas now they are around 75 basis points higher. The lending rate spread, meanwhile, has increased by even more, from 200 basis points to 275 basis points.

As the Survey points, many commentators have emphasised that transmission is limited by high administered and small savings rates. Bankers had however said that linking small saving scheme interest rate to the market would be beneficial. The interest rate being offered by banks on a deposit for a year hovers around 7.5-8 per cent, much lower than the 8.7-9.3 per cent being offered on small saving schemes. Recognising this, the government has reduced rates on some small savings schemes to make them more responsive to market conditions.

Liquidity is also an important factor as these can reinforce or negate the changes in policy rates, the Survey points. It said also said that if liquidity conditions are tight, commercial banks will be extra cautious about passing on policy rate cuts into lower deposit rates, for fear of losing customers and hence more liquidity.

In order to ensure faster transmission of rate cuts the Reserve Bank of India has said that all banks will have to follow a new uniform methodology from the next fiscal for calculation of base rate on the basis of the marginal cost of funds. Bankers are also hoping that this would ensure that availability of bank credit at interest rates which are fair to the borrowers as well as them.