Banks should reduce rates for existing borrowers too: RBI:

Banks should reduce rates for existing borrowers too: RBI:

Context:

The RBI reduces the policy rate while flagging multiple concerns on the economy

Introduction:

  • As some of the upside risks to inflation have not materialize, the Reserve Bank of India on Wednesday decided to cut the key policy rate or repo rate by 25 basis point(bps),taking it to its lowest  in six –and-half year
  • The Reserve Bank of India governor Urjit Patel said he expected lender to pass on lower loan costs to borrowers who had not received the full benefits of the reduction in the policy rate.

RBI initiatives:

  • The Reserve Bank of India also plans to review the MCLR and Base Rate mechanisms to address the issue of inadequate monetary transmissio
  • The banking regulators pointed out that bank mainly reduced rates for segments where competition was high as in the case of home loans and personal loans
  • The central bank has reduced the repo rate by 200 bps since January 2015
  • The RBI decision largely dependent on the three factors GST, Demonetisation and Oil, consensus largely forecasted that a rate cut is on the anvil.

Reasons for rate cut

  • Apart from softness in food and fuel prices, the apex bank also noted interestingly that the inflation in transport and communication services were depressed by the pricing war in the telecommunication space
  • Pricing power for industry also remains subdued as per the RBI survey
  • Implementation of farm loan waiver by state may result in fiscal slippages as well as the timing of the state implementation of the 7th CPC
  • Versus the last policy, RBI recognizes that growth, industrial production and private capex are very sluggish, indicating weakness.

Impacts:

  • On new lending, the transmission has been much stronger, specially in those segments where there is lot of competition-housing loans, personals loans where the NBFCs also play a big part
  • While banks cut the marginal cost of funds based lending rate (MCLR) sharply in January by to 90 bps the reduction in the base rate, which was the earlier loan pricing regime, was much lower
  • MCLR has been operational only from April 2016, a large proportion of loans are still linked to the base rate and such borrowers have not benefited to the extent of the new borrowers
  • The difference between the base rate and MCLR, for some banks, is as high as 90-100 bps
  • The RBI said that it will address Base Rate rigidity to improve transmission
  • By cutting the policy repo rate by 25 basis points, the Reserve Bank of India has opted to play safe while nominally acceding to the clamour for softer lending rate
  • There is no clarity on whether and when State governments will implement salary and allowance increases following the Centre’s implementation of the seventh pay panel related hikes.
  • The RBI governor expressed concern that CPI inflation might inch up to 4% by Q4. They might cut again when CPI inflation undershoots their estimates, which has been the case in the recent past
  • A shift to ‘accommodative’ stance would have better from the sentiments perspective
  • This is detrimental to credit expansion and economic growth
  • The RBI governor expressed concern that CPI inflation might inch up to 4% by Q
  • There is lack of incremental private sector investments, job creation is being hampered.

Key points:

  •  It is important to note that India has the second highest real interest rate in Asia presently
  •  On the state of the economy, the Monetary Policy Committee was of the view that there is urgent need to reinvigorate private investment, remove infrastructure bottlenecks and provide a major thrust to the Pradhan Mantri Awas Yojana for housing needs of all
  • On their part, the Government and the Reserve Bank of India are working in close coordination to resolve large corporate borrowers and recapitalize public sector banks within the fiscal deficit target.
  • An important point is that the RBI has not changed the policy stance, which continues to be neutral
  • Among the market development initiatives announced by RBI, it is noteworthy to mention the separate limit in IRF(Interest Rate Futures) to the extent of Rs 5000 cr for FPI
  • RBI also plans to review the MCLR and Base Rate mechanism to address the issue of inadequate monetary transmissions.
  • Steps are being taken to close out the gap of information asymmetry between borrowers and lenders by having a comprehensive PCR (Public Credit Rating) for which RBI plans to set up a task force.

Challenges:

  • RBI has been facing challenge of non-transmission for a while, but a silver lining is developing at the macro level where the Forex reserves of India are becoming big.
  • Forex reserves eventually will ensure fall in currency premiums and that will result in foreign capital flowing into the economy at substantially lower rates.
  • Markets are overheated but reluctant to fall, a huge pile of cash getting built in the system and waiting to be deployed, that will act as a shock absorber at every weakness.
  • Global borrowing rates are subdued and currency risks now tapering off will result in lower rates offered in India.

Conclusion:

Long term money should be committed at these levels as well. Barring any global event, the outlook is positive.

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