The 10-years GSec has moved down by 110 bps between August 10, 2018, and August 9, 2019, 364-days Tbill by 143 bps, 91-days Tbill by 124 bps, and call rate by 90 bps.
It is now almost axiomatic that whenever the MPC convenes, there will be a rate cut in case CPI inflation is reigning at less than 4% and the risk factors are minimal. At present, oil price is down, and there is little possibility of a spike as every time supply comes down from the cartel, the US tends to provide the required substitution. Besides, the world is moving towards less oil consumption. The monsoon has turned normal and, while there can be marginal shortfalls, it is unlikely that prices will shoot up. Yes, prices of vegetables can create panic at times due to the recent flooding in several parts, but that would be temporary in nature.
The important question is whether or not we have been relying too much on monetary policy for growth, and lost the plot along the line. The economy has been stagnating as several sectors show declining growth and job losses. The government has chosen to stick to fiscal prudence and sought to revive animal spirits through some ‘talk’. The recent measures announced by the FM are more in the nature of addressing pain points of industry, like auto or SME, or banks and not any additional fiscal outlays. The withdrawal of the surcharge on tax to be paid by FPIs is probably the only one which has fiscal implications. But, plain talk, not backed by financial resources, has not worked in the last three years. That is the difference between ‘RBI talk’ and ‘government talk’. ‘RBI talk’, also sometimes loosely called ‘open mouth operations’, has worked to cool the currency and, at times, interest rates that are market determined. But, when it comes to the government, industry does not seem to be convinced and is waiting for a ‘delta’ to flow in the form of additional expenditure announcements. This is not happening.
Captains of industry have been asking for rate cuts more out of habit, and RBI and MPC have been obliging with alacrity. When it was 25 bps, they argued that it was anaemic and something more potent was required. Last time, it was 35 bps and, hence, industry should be happy. RBI and the government have both been haranguing banks to lower rates, and the famous epigram of all discussions in the media is that the ‘transmission is rigid’. Let us see how these numbers have moved in the last one year or so.
The repo rate has come down by 110 bps in the last year, ending August 9, 2019. The first point of action has to be the deposit rate as it feeds into the MCLR, which becomes the indicative rate for borrowers. The one year deposit rate has moved from 6.25-7% on August 10, 2018 to 6.35-7.3% on August 9, 2019. The midpoint rates have moved from 6.625% to 6.825%. The mid-point savings bank rate has, on the other hand, come down from 3.75% to 3.375% in this period. The weighted average rate on term deposits has gone up from 6.72% in June 2018 to 6.84% in June 2019. Quite clearly, banks are cautious here as lowering deposit rates in general will affect the supply of funds and, given that deposits are 76-78% of total liabilities, lower repo rates do not necessarily translate to lower deposit rates.
Let us look at the lending side. The MCLR has moved up from an average of 7.9-8.05% to 7.9-8.4%—a mid-point increase from 7.975% to 8.15%—at a time when the repo rate has been lowered. The WALR on new loans has moved from 9.45% to 9.68% (June to June), while that on outstanding loans has increased from 10.26% to 10.43%.
The question is why lending rates are not coming down, when policy rate has fallen sharply in the last year? First, MCLR is a function of the deposit rates and, if the latter does not come down or increases, it does not really point to lower lending rates. Second, even if the MCLR comes down, the effective rate for customers may not come down if credit risk perception is higher. And, at times when the economy is in an acknowledged state of slowdown, with corporate sales growing at an anaemic rate of 5% in the first quarter, it would be incorrect not to price in this risk when lending to most clients. That is why the WALR has gone up during this period. Therefore, the issue of transmission must be left to banks, rather than being decreed from above, as interest rate is the price for capital which should ideally be the reflection of demand and supply. Supply is restricted by deposits growth while demand is screened by banks, based on quality, where credit risk matters. On the demand side, it should be realised that it has not kept pace as there is still surplus capacity with industry. Also, private sector investment in infrastructure is still limited and, hence, comes in the way of demand for funds.
The market reaction to interest rates has, however, been amazingly proactive. The 10-years GSec has moved down by 110 bps between August 10, 2018, and August 9, 2019, 364-days Tbill by 143 bps, 91-days Tbill by 124 bps, and call rate by 90 bps. This means that the government bond market reacts well, and those borrowing here tend to gain the most. Here, the biggest beneficiary has been the government, which has a gross borrowing programme of `7 lakh crore this year and can lower costs by over 100 bps and save Rs 700 crore. Also, the gross Tbill issuance for the year would be above `10 lakh crore, getting in a benefit of Rs 1,000 crore in interest payments on an annualised basis relative to last year.
How about the corporate bond market? Here, interestingly, the corporate bond spreads over GSecs has moved upwards quite perceptibly. It was by 37 bps for AAA bonds, 71 bps for A rated bonds and 51 bps for BBB rated bonds during this one year period. Clearly, the risk perception on commercial lending has increased and, hence, while GSec rates have moved downwards, the market has priced corporate bonds higher. And, if the market reaction is testimony of the final interest rate, credit has actually been priced higher.
The conclusion is quite revealing. Lowering of rates by RBI definitely helps the government lower the cost of borrowing, which can be up to Rs 2,000 crore a year, depending on the tenure of issuance. However, when it comes to commercial credit, banks cannot, and do not, respond the way the central bank would like as they have to also consider the growth in deposits, which is mainstay for them and, hence, transmission will be slow, depending on their requirements. Also, credit risk has to be priced appropriately; and ex poste numbers do reflect the perception. At a broader level, it raises the issue of whether we should at all expect banks to lower their deposit and lending rates when the RBI lowers the repo rate, especially when the market does not support such actions as seen in the bond spreads.