Rate transmission likely to be RBI's key focus

Top 5 banks of the country reduced their base rate by maximum 15 bps following the repo rate cut by RBI this year

With banks yet to cut lending rates despite the 75-basis point fall in the repo rate since January, inducing them to do so is likely to be the Reserve Bank of India (RBI)’s key focus when it announces the mid-quarter review of monetary policy on Monday.

This year, among the top five banks in the country, the sharpest cut in base rate stood at 15 basis points. RBI has cut the repo rate thrice this year. Currently, the rate stands at 7.25 per cent. Bankers, including State Bank of India Chairman Pratip Chaudhuri, had indicated a rate cut by RBI might not result in a lending rate cut by banks because their cost of funds wouldn’t fall significantly. Instead, banks have sought a cut in the cash reserve ratio (CRR), which would release money that could be deployed in interest-earning assets. Banks’ CRR balance with RBI doesn’t earn them any interest.

CRR is the proportion of total deposits a bank has to keep with RBI as cash. It is four per cent of banks’ net demand and time liabilities. Though CRR has been cut by 200 basis points since January 2012, liquidity is still in fight.

“With market expectations of a repo rate cut on June 17 now tempered due to the falling rupee, a CRR cut may act as a key signalling tool for foreign institutional investors and equity investors, as visibility over continued monetary loosening has emerged as a key catalyst for Indian equity markets,” said Deutsche Bank’s Abhay Laijawala and Abhishek Saraf.

  While a few believe RBI would focus on monetary transmission, they do not expect a CRR cut. “The June 17 policy meeting would be focused on ensuring better transmission of monetary policy. Tight banking system liquidity has been one of the reasons for the sluggish monetary policy transmission. However, liquidity has improved in June and returned to RBI’s comfort zone,” Standard Chartered Bank said in a note to clients. The bank feels as of now, a CRR cut is unlikely. “CRR is already at historically low levels and should be used judiciously, keeping in mind possible dislocations in global markets,” it said.

Indranil Sen Gupta, India economist, Bank of America Merrill Lynch, foresees a cut in CRR. “We are replacing our call for a 25-basis point liquidity adjustment facility repo rate cut with a 25-basis point CRR cut on Monday. RBI may not want to court controversy by cutting rates when the rupee is just stabilising,” he said, adding he expected lending rates to fall 50-70 basis points by March 2014. “A CRR cut will ease liquidity and reduce the cost of funds for banks. I am expecting a 50-basis point CRR cut. If there is a CRR cut, OMOs (open market operations) will be delayed,” said Arvind Chari, senior fund manager (fixed income), Quantum Mutual Fund.