RBI: (Un)Puzzled

We all have solved some kind of puzzle in our school/college days or even during our working careers. If it’s an easy puzzle to crack we would very well do it in a handful of minutes. But, if you come across a tricky one you can’t have the same approach as the former. It will require out-of-the-box thinking to be able to crack it.

You must be wondering what sort of puzzle we are talking about. Hold on! The Reserve Bank of India (RBI) has also been trying for months to solve a puzzle (fixing the Indian Economy) through all its conventional methods. But it has finally acknowledged that the road to victory is not going to be a smooth ride. So, it has done an “out of the box” thing that none of us would have imagined.

The RBI has announced a slew of measures ranging from Long Term Repo Operations (LTRO) to giving Cash Reserve Ratio (CRR) exemption to banks while lending to sectors such as housing, auto, and micro, small and medium enterprises (MSMEs). The focal point of all these measures is to re-ignite credit growth in the economy, which has been pretty much absent off late.
CRR is the amount of funds that the banks have to maintain with the RBI at all times. It is currently fixed at 4 per cent of deposits. So, giving exemption on the CRR will definitely allow the banks to lend more, but will it be enough to spur credit growth like before?
We think that’s not going to be enough.


Firstly, let’s take the case of auto loans.
The equated monthly instalment (EMI) on a 9 per cent car loan of INR 5 lakhs for a tenure of 5 years comes to INR 10,379. Now, suppose as a result of the RBI move, the interest rate falls by 10 bps. In that case, the EMI will be around INR 10,355 or INR 24 less. Even if we take a more sanguine approach, like say fall in interest rates by 50 bps to 8.5 per cent, the EMI on a car will be INR 121 less only.
If someone tells you that you will have to shell out INR 121 less as EMI for an auto loan, will you just rush to the bank and avail a loan for your car?
Definitely no!
The main point is that the amount is not at all significant to create a shift in the spending behaviour amongst the common people. A person will take a loan to buy a car, only if he/she feels confident of repaying the EMIs. But sadly, that confidence is currently missing owing to the sluggish job market. Also, the per capita income in FY20 is likely to grow 6.6 per cent, the slowest since 2002-03; the foremost reason for a decline in consumption.
Secondly, the measures will unlikely lead to lower interest rates because from 1st October all retail and small business loans have moved to the new external benchmark based lending rate – repo rate for almost all banks from the earlier marginal cost of funds (MCLR) based lending rate. While the MCLR is based on the bank’s incremental cost of funds, loans that are linked to external benchmark change only when there is a movement in the benchmark. So, any loan which is linked to the repo rate will not see a cut in the interest rate unless the headline rate comes down.
Given the current economic situation and a sharp rise in the projection of Consumer Price Inflation (CPI) to 6.5 per cent for Q4FY20 by the MPC, a reduction in the external benchmark rate is unlikely to come down soon, and consequently the interest rates.

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Source: Livemint & RBI. 

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