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All Eyes On Retail Banks' Rate Cuts Now

To be fair, banks have significantly reduced lending rates on fresh loans by 90 basis points, which is an appreciable pass through

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The RBI cut its policy repo rate by another 25 basis points in last week's monetary policy meeting to 6.5 per cent. In explaining its stance, the bank cites the fact that "Given weak private investment in the face of low capacity utilisation, a reduction in the policy rate by 25 bps will help strengthen activity and aid the Government's initiatives".

While there is little denying the fact that India's investment cycle remains weak, there are signs of recovery as well. Last week, we spoke of how the first signs of sure recovery - led by credit growth - are here.

However, the pickup so far is not enough to get the investment cycle moving in a significant way. At present credit growth is just over 10% yoy, which is still far lower than the over 30% growth rates witnessed in India's highest growth phase during the mid-2000s.

The key question, then, is: How fast can credit creation grow from here?

The answer to this is dependent on banks' responsiveness to RBI's policy rate cuts. In the central bank's own words: "Perhaps more important at this juncture is to ensure that current and past policy rate cuts transmit to lending rates.".

This is a significant remark at a time when retail banks have been slow in passing on policy rate cuts to the final consumer. The RBI's latest Monetary Policy Report, points to the fact that from December 2014 to March 2016, policy interest rates were cut by 1.25 percentage points. However, banks' median lending rate, by comparison, was reduced only by 60 basis points. This is a whole 65 basis points lower than the total policy rate cut over the period.

To be fair, banks have significantly reduced lending rates on fresh loans by 90 basis points, which is an appreciable pass through. However, a large part of loans are in the form of outstanding credit, where rate reduction has been slow. Only 53 basis points cut has been witnessed so far since the end of 2014.

Even more glaring is the fact that banks have been quite quick to cut deposit rates by comparison. The median term deposit rate is down by 80 basis points - a 20 basis points faster reduction than that seen in the average lending rates.

While it is to be expected that there is an across the board fall in interest rates due to a reduction in policy rates, changes between deposit rates and lending rates should ideally move in tandem. And for now, the focus is on how much faster lending rates can fall, to encourage investments further.

Disclaimer: The views expressed in the article above are those of the authors' and do not necessarily represent or reflect the views of this publishing house. Unless otherwise noted, the author is writing in his/her personal capacity. They are not intended and should not be thought to represent official ideas, attitudes, or policies of any agency or institution.

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Manika Premsingh

Economist and Founder, Orbis Economics

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