Right now, bankers are more concerned about RBI’s decision on the moratorium, and one-time loan recast
It has been clear for many years now that cuts in the repo rate don’t really prompt banks to lower lending rates immediately. Banks drop interest rates on loans only when they are sure they can bring down the cost of funds and protect their margins. The transmission has been faster in the past six to eight months primarily because interest rates on deposits have been slashed and since banks are confident it will be possible to trim them further without losing out on liquidity.
To that extent, a cut in the repo on Thursday will see banks lowering loan rates; some have done so ahead of the policy announcement. However, given headline CPI inflation for June was 6.1% y-o-y, following 7.2% in April and 6.3% in May, all well above the projected path, there is a feeling the central bank will pause. The recent uptick in core CPI is the result of higher gold, transport and communication, education and personal care. However, headline inflation is expected to taper off to 3-3.5% levels by the end of 2020 with much of the supply shock-driven increase taken care of with the unlocking and a big moderation in the prices of food.
Given the dire straits the economy is in with real GDP expected to contract by anywhere between 6-9% in FY21, the central bank should be willing to overlook the temporary disruptions and announce at least a token cut. That would signal that it is batting for growth, and should help lower yields at the long end. To be sure, we have seen a cumulative 250 basis points cut since 2019—and 115 bps since the start of the pandemic, to the current levels of 4%. Also, out-of-turn cuts are possible, but a snip on Thursday would nonetheless be reassuring.
More critically, though it is lending that is stagnating and needs to pick up; credit growth has been hovering close to 6%, and the credit deposit ratio has fallen by 355 basis points between April and mid-July. The Reserve Bank of India (RBI) has been trying to coax bankers to lend by lowering the reverse repo rate, but in vain; the risk aversion persists. They cannot be faulted in today’s extremely difficult environment in which businesses are shaky. It simply does not make sense to risk capital when financials of companies are stretched, and so many of them are shaky. Consequently, a cut in the reserve repo rate—perhaps by 25 basis points from 3.35% at present—may disincentivise banks from parking their surpluses with the central bank, but only at the margin.
Right now banks are hoping the central bank does not extend the six-month moratorium, which ends on August 31. Ideally, decisions on deferring repayments are best left to bankers. What lenders are all looking for is a one-time restructuring that would allow them to classify exposures as standard even if these are not so in reality; there is a need to help the industry, and these are challenging times, but forbearance of this nature creates a moral hazard as also indiscipline within banks. While giving lenders lenient terms and timelines to repay their loans, RBI should insist that banks classify these exposures correctly. This will ensure that lenders are choosy about recasting loans. Meanwhile, RBI should impress on the government the urgent need to capitalise banks. That would prompt them to lend more, thereby helping the recovery.