Monetary transmission, a key concern for RBI

Bankers argue that there has not been much offtake in credit from the corporate side

The markets are expecting a reduction in indicative policy rates (repo rate) along with a cut in Cash Reserve Ratio (CRR) when the Reserve Bank of India announces its Annual Monetary Policy for 2013-14 on Friday.

When bankers met the RBI Governor D. Subbarao earlier in April in their pre-policy meeting, they had suggested a 50 basis points cut in the CRR and a further cut in the repo rate. Their argument was that the deposit growth had been slightly lower than the RBI expectation (of 15 per cent growth) with liquidity remaining tight.

The major issue arises with regard to RBI’s policy is the transmission of rate cut by banks to consumers, which, the bankers believe, is possible only with a cut in CRR. They are reportedly of the view that just a cut in repo rate is not enough.

CRR, the portion of deposits that the banks are required to maintain with the RBI, is 4 per cent now. The repo rate, the rate at which banks borrow funds from the RBI, is 7.50 per cent. The RBI cut the CRR from a peak of 6 per cent by 200 basis points to 4 per cent, and the repo rate by 100 basis points from 8.5 per cent to 7.5 per cent.

Bankers argue that there has not been much offtake in credit from the corporate side. Further, there is also a slowdown in the consumption demand. In the light of these, bankers feel that there has to be a pick-up in the confidence levels in the economy.

The transmission of monetary easing is more likely to be driven by a cut in the CRR than a reduction in the repo rate, which will enable banks to offset the impact of a base rate reduction on earnings, says India Ratings & Research. It estimates that the weighted average reduction in the base rate of banks since early 2012 has been restricted to 40 basis points (as against 100 basis points of cuts in the repo rate). Some private sector banks, in a bid to maintain margins, have not cut their base rates at all. The RBI reduced the CRR by 200 basis points during this period. The stunted transmission of monetary easing also stands in contrast to the government bond market, where the 10-year bench-mark bond yield has come off by close to 100 basis points compared with end-April 2012.

Indian banks’ structural shift to funding a large share of their assets with short-term deposits (50 per cent of total deposits in March 2012) contributes to almost perennial refinancing pressure in the banking system. This is reflected in persistent tight liquidity conditions.

“Banks are unable to realise benefits of interest rate cuts on their cost of funds due to their shift to a shorter tenor liability profile and the strong seasonal growth in quarters ending March, when they refinance a large share of their liabilities at elevated deposit rates,” argues India Ratings & Research. Another rating agency ICRA believes that decline in commodity price provides room to cut policy rate to stimulate slowing economic growth.

Based on a relatively more benign outlook for inflation and the current account deficit following the recent moderation in commodity prices, as well as the continuing sluggishness in investment activity and domestic consumption sentiment, ICRA expects the RBI to reduce the repo rate by 25 basis points, with a high likelihood of another 25 basis points cut in the policy rate during the remainder of calendar year 2013. It expects the persistence of retail inflation in excess of 10 per cent would keep inflationary expectations elevated.