What does RBI’s 25 bps repo rate cut mean to you and me?

We may have to wait till RBI makes known its monetary policy stance for 2013-14 sometime in April-May, 2013. Till then interest rates may continue at the present level, as no bank has committed to lower the base rate even after a week of the announcement of the mid-quarter monetary policy review last week

The Reserve Bank of India (RBI), while announcing the mid-quarter monetary policy review last Tuesday, cut the repo rate by 25 basis points (bps) to 7.50% without making any changes in the cash reserve ratio (CRR), which has been retained at 4%.

To know the implications of these actions of the RBI, let us first understand what is meant by repo rate and then see how this rate affects you and me.

What is meant by repo rate and reverse repo rate?

Repo rate is the short form of “repurchase rate”.  It is the rate at which banks borrow money from the RBI for short periods by selling their surplus government securities to the central bank with an agreement to repurchase the same at a future date at a pre-determined price. It simply means the rate at which RBI lends money to commercial banks against the pledge of government securities whenever the banks are in need of funds to meet their day-to-day obligations.

In the policy review announced last week, the RBI reduced this repo rate by 25 basis points, i.e. by 0.25% (100 basis points equals to 1%) to 7.5% from the earlier rate of 7.75%. This means that the banks are now able to borrow funds from RBI a little cheaper by 0.25%.

Reverse repo rate is the rate of interest offered by RBI, when banks deposit their surplus funds with the RBI for short periods. Whenever the market is flush with funds and banks have no avenues to lend immediately, they deposit such funds with RBI and earn interest on such funds.  

What are the effects of repo rate cut on banks’ customers?

The cut in the repo rate, for the second time in 2013, is seen as an attempt by the RBI to spur growth. So whenever the repo rate is cut, the expectation is that both the deposit rates and lending rates of banks would come down to some extent, though not to the same extent as the cut in the repo rate. But this does not happen every time and it is not happening now also. The lending rate of banks goes down to the existing bank borrowers only when the banks reduce their base rates, as all lending rates of banks are linked to the base rate of every bank. In the absence of a cut in the base rate, the repo rate cut does not get automatically transmitted to the individual bank customers, so much so, many times the borrowers of banks do not get the benefit of the repo rate cut by the RBI and are nonplussed about this much ado about nothing.

The banks are not willing at present to pass on any rate cut to their existing borrowers despite the RBI cutting the repo rate due to the following reasons:

1. During the last 11 months of this financial year, the deposit growth in banks has been subdued at around 10% to 11% while the credit growth has been around 15% to 16 %. So banks are trying to garner resources to meet the credit needs of their customers and many banks have recently raised the deposit rates by about a quarter percent to encourage flow of deposits into banks. When the deposit rates have been increased, there is no case for reducing the lending rates, as any reduction in lending rates without corresponding reduction in deposit rates would eat into their margins and hurt their profitability.

2. Banks are more comfortable if deposits grow more than advances, as customer deposits are more stable and available for longer periods, thereby helping them to reduce their asset-liability mismatch, whereas borrowing from the RBI is for short periods and is resorted to only to meet urgent funds requirements on a day-to-day basis.

3. Banks were expecting a cut in the cash reserve ratio (CRR) also, which would have provided them with their own funds that were impounded by the RBI without paying any interest. If these impounded funds were released, banks would have been happy to pass on some part of the benefit to their borrowers, but the RBI did not cut CRR this time, as the central bank feels that it may fuel inflation, affecting purchasing power of people.

In short, the reasons for banks not reducing their lending and deposit rates are summarized in the following report of CRISIL:

 “We  believe  that  the  25  bps  cut  in  the  repo  rate  will  not immediately  translate into  a proportionate  reduction  in lending rates. Subdued deposit mobilisation and an all-time high credit-deposit ratio (78.1% as of 22 February 2012) will constrain banks’ ability to cut deposit and lending rates across the board. …during April-February 2012-13, the median base rate reduction of 10 banks was 20 bps, while the RBI reduced repo rate by 75 bps and the CRR by 75 bps during this period,” said ratings agency CRISIL in a report.


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When can we expect the interest rates to come down?

In the monetary policy review, the RBI expressed concern over the unrelenting rise in food inflation, which is causing considerable hardships to a large number of our people, who are below the poverty line.  The rising inflation is also eating into the savings of a large majority of middle-class population resulting in sluggish deposit growth and diversion of bank deposits into other unproductive assets like real estate and gold as a hedge against inflation. In the words of RBI, “the foremost challenge for returning the economy to a high growth trajectory is to revive investment. A competitive interest rate is necessary for this, but not sufficient. Sufficiency conditions include bridging the supply constraints, staying the course on fiscal consolidation, both in terms of quantity and quality, and improving governance… Accordingly, even as the policy stance emphasizes addressing the growth risks, the headroom for further monetary easing remains quite limited.”

From the above statement, it is apparent that unless inflation comes down to RBI’s comfort levels, further easing of interest rates appear remote. As the government borrows more to bridge the budget deficit it leads to interest rates going up adding to inflationary pressures in the economy. The ball is, therefore, in the central government’s court, which has committed to the Parliament that steps are being taken to contain fiscal deficit within the permitted levels, and take such other steps to bring inflation under control to revive investment and spur growth. We may therefore, have to wait till RBI makes known its monetary policy stance for 2013-14 sometime in April-May, 2013. Till then interest rates may continue at the present level, as no bank has committed to lower the base rate even after a week of the announcement of the mid-quarter monetary policy review last week.

However, banks may selectively quote lower rates for new home loans and vehicle loans, etc. for short periods, just to ensure that they are not out of the market for their retail lending operations.

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(The author is a banking analyst and he writes for Moneylife under the pen-name ‘Gurpur’)

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