State Bank of India cutting interest rates on 90% of its savings deposits not only opens up the possibility of banks passing on lending rate cuts should RBI choose to cut repo rates after its monetary policy meeting later today, it is symbolic of both the lack of demand for credit and the fact that, as a result of this and demonetisation, banks are flush with liquidity. Between November last year and now, while deposits grew 5.3%, loan growth was a much lower 4.8%. So, when 60% of the post-demonetisation deposits that SBI got moved out, the bank had the choice of increasing its MCLR—which is based on the cost of funds and so rises as lower-cost deposits move out—or to cut deposit rates to maintain its margins. The fact that it chose to cut interest rates on deposits of less than Rs 1 crore means SBI doesn’t fear any great exit of deposits and, to the extent deposits flow out, it doesn’t really matter in the absence of any meaningful pickup in demand for credit.
It is, of course, true that the deposit rate cut makes bank deposits relatively more unattractive compared to small savings—nominal interest rates on National Savings Certificates are still 7.8% vs 4% in savings deposits and 6.25% for 5-year bank deposits—but what is important to keep in mind is that, at 2.46%, the real interest rates on savings deposits are still positive compared to many years in the past when they were negative. In FY14, for instance, while savings bank deposit rates were 4%, consumer inflation was a much higher 9.5%. Even in FY17, real interest rates on bank deposits were minus 0.5%.
How soon other banks will follow SBI is not clear, but it should happen because that will increase their earnings and also because the economy remains fragile and so demand for credit will remain subdued for some time to come. It is true the contractionary July PMI of 47.9 makes the economy look worse than it is, and was influenced by the temporary destocking prior to the introduction of GST. But it was quite subdued even before that—it was 50.9 in June, 51.6 in May and 52.5 in April, suggesting a loss of momentum for several months. IIP has also been slowing, from 3.8% in March to 2.8% in April and 1.7% in May. And while passenger vehicles momentum was a moderate 11.3% between January and May—the July growth was a result of restocking following destocking in June—medium and heavy commercial vehicles have been de-growing over the last three months; sales contracted 51% in April, 29% in May and 7% in June. Had it not been for robust capital expenditure by both PSUs as well the government, GDP growth would be a lot slower than it is right now since private sector capex continues to stall. With inflation at a historic low of 1.5% in June—the last time we saw such low inflation was in 1999 and, before that, in August 1978—and many forecasters looking at a benign inflation in FY18, chances are RBI will cut repo rates later today. And with banks desperately looking for borrowers—since January, credit growth has averaged just around 5%—chances are monetary transmission will be faster this time around, especially with the government also keen to see this happen.