A status quo by the Reserve Bank of India (RBI) on the key repo rate on Tuesday — on the grounds that rising retail inflation warranted some vigilance — has left little room for banks to cut their loan rates immediately. However, with the new formula for calculating for base rates to be out later this week, borrowers can hope for lower interest rates soon.
The central bank left the repo unchanged at 6.76% as widely expected, following the 50-basis-point cut in September, making no alterations in the reserve or cash requirements.
RBI governor Raghuram Rajan said the central bank “will use the space for further accommodation when available”.
The rise in retail inflation for the third consecutive month in October, the governor observed, bore watching. The RBI has revised its forecast for inflation to 5% by March 2017. However, it retained the 7.4% GDP forecast with Rajan saying the economy was “well and truly” in the midst of a recovery though there were areas of weakness.
Economists believe the pause on rates could be a prolonged one. “We think the bar for further easing is high given the challenge of lowering underlying inflation from 5.5% now to 5% in early 2017, a time when growth is likely to be ticking up. For now, the RBI may be best off focusing on transmission issues,” wrote Pranjul Bhandari, chief India economist at HSBC Securities and Capital Markets.
At a press conference, Rajan said the new method, based on the marginal cost of funds, would allow banks to act faster. “We’re focusing on transmission because less than half the cumulative 125 basis points reduction in policy rates has been passed by banks,” Rajan said. The intent, he said, was to enable banks to price incremental loans based on the marginal cost. Currently, banks set the floor lending rate or the base rate according to the average cost of funds.
Rajan said that the government was “examining” linking the interest rate on small savings to market interest rates, a move that will aid transmission. Thus far, banks have been hesitant to reduce interest rates on deposits beyond a point apprehending money will move away to small savings schemes. The clean-up in banks’ balance sheets would also free up room for fresh lending, the RBI believes.