Welll! Welll! Welll!
The RBI has surprised all of us by deviating from its tradition, and cutting the repo-rate by an unprecedented 35 bps. All of us were sure that there would be a cut of 25 bps, but not many thought about 35 bps . By doing so, the RBI has acknowledged the economic slowdown prevalent in the country plus the geopolitical tensions hovering around the world. (US-China Trade War, Middle East Tensions).
But what next?
No matter how much the rate cut is, unless there is an effective monetary policy transmission in the country, things won’t ameliorate. Leaving out the latest MPC meeting, the RBI has cut rate by 75 bps, but how many of you have seen your banks cutting the lending rate by even half that amount. We guess none. SBI was the first one to cut lending rates by meagre 10 bps, and off late HDFC Bank has followed suit.
So why there has been a lacklustre transmission of interest rates by the banks in our country. Well, we will emulate some of the reasons for the same:
1. Lending out all the deposits: The credit-deposit ratio has gone up in the past 2 years to 76.3% from 72% as of 19th July. This means that for every 100 rs as deposit, the banks lend out 76.3 as loans, and after taking into account Minimum Statutory Liquidity ratio of 18.75% and Cash Reserve Ratio of 4% which the banks have to invest in G-secs. Banks have been lending out almost all the deposits. As such, it has not been possible for banks to cut the interest rates on their deposits and hence on their loans.
2. Increased competition from Small Savings Scheme: The banks have to compete with the small savings scheme from the post office for the public deposits. However, deposits raised through these schemes have shot up quite fast. In the last 4 years there has been a 361% increase in their deposits from INR 32,226 crores to INR 1.16 trillion. So, the competition between banks and small savings scheme has increased, which in turn has made the banks reluctant to cut their deposit rates and hence lending rates. Moreover, interest on many small savings scheme is around 8% and some of them allows for a tax deduction, whereas interest rates on fixed deposits is hovering around 7%.
3. The National Small Savings Fund conundrum: The money collected by the small savings scheme goes into the NSSF. This NSSF has been investing in G-secs in the past, and off late a lot of money has been raised by lending to public sector enterprises. For eg: as of 1st April, 2018, the Food Corporation of India (FCI) owed INR 1.21 trillion to the NSSF and as of 1st April, 2019 it owed INR 94000 crore to the NSSF. The FCI, on behalf of the Government procures, distributes and supplies food. In return it gets compensated by the Government in the form of food subsidy. However, the Government has been allocating far less than the actual amount for food subsidy to FCI. For eg: in FY19, the total food subsidy that the FCI claimed stood at INR 2.61 trillion, but the Government had allocated only INR 1.02 trillion; a difference of INR 1.60 trillion. This is causing the FCI to borrow the deficit amount from NSSF and the banking system to keep itself running. In FY20, the FCI expects to borrow INR 1.91 trillion from the NSSF. All these borrowings can happen only if there is a continuous inflow of fund into the NSSF, which depend on the investments made into small savings schemes. Investments into these schemes are benefited because of higher interest rates than fixed deposits which a bank gives. So, higher interest rate benefits the Government and helps them show a lower fiscal deficit.
4. Falling Household Savings: This is an important aspect which needs to be kept in mind. Household savings of Indians have been falling over the years, whereas total borrowings of the government and its companies have gone up. In such a scenario, we feel lowering interest rates would only make the problem worse.
The RBI has done its part, and the onus is now on the banks to pass on the benefit of rate cut to the public. But, for that interest rate on small savings scheme needs to come down, which as per aforementioned points looks highly unlikely.
Do let us know your views!
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