RBI Passes on More Rate Cuts to Borrowers

Posted On Tuesday, Dec 01, 2015


RBI held its Monetary Policy Review meeting today, and as expected it left key interest rates unchanged and also maintained its “accommodative” stance; although, it comes with a bit of caution. An “accommodative” stance is where a central bank tries to stimulate economic growth by lowering key interest rates, making money less expensive to borrow.

In his speech RBI Governor Mr. Raghuram Rajan said the potential inflationary impact of the 7th Pay Commission would be viewed by RBI with caution, as also on the need to be vigilant towards the price rise in some food products going forward.

The RBI has still maintained its inflation target of around the 5.0% mark in March 2017. If you would recollect, the RBI’s inflation target now is 5.0% by Jan-Mar 2017. Given the factors laid above and the impact of increase in service tax in the next budget, it would be a great challenge to meet the 5.0% target.

We thus hold our view that the next rate cut (25 bps) would be possible only post the Budget. With the RBI highlighting the impact of Pay Commission on the fiscal numbers, it would want to wait and see the markets’ response to the Government’s ability to meet the 3.5% Fiscal Deficit target. If the market senses that the Budget numbers are credible and the Government has resources to meet the 3.5% target, it would improve investor confidence and the RBI will be able to utilize the limited space available to cut rates to 6.5%. Any reduction in interest rates post that would depend on the RBI achieving the 5.0% inflation target.

Transmission of rates by banks
More than the quantum of rate cuts the RBI should now focus all its energy on improving the transmission. The RBI has cut rates by 125 bps since January but total lending rate cuts by banks have been less than 60 bps. For the economy to benefit from the low inflation and monetary accommodation; lending rates have to fall more, and quickly.

Even in the bond markets, post the fall seen in 2014 in anticipation of rate cuts; the bond yields haven’t fallen by much as supply outstrips demand.

In an accommodative cycle, the liquidity situation has to be remain plentiful for the banks’ cost of funds to fall and which banks can pass on to the borrowers. Data that we maintain shows us that Core Liquidity (liquidity directly managed by the RBI) which was surplus to the tune of INR 800 bln in August 2015 has turned into a deficit of INR 250 bln in November. The RBI needs to ensure that Core Liquidity swings back into surplus so as to ensure that banks can pass on the benefit of lower cost of funds by cutting lending rates. As foreign inflows have dried up the RBI will have to resort to buying Government bonds to infuse durable (long term) liquidity.

Takeaways for you
RBI has promised to come up with a new methodology for banks to determine the base rate for loans based on the marginal cost of funds. Once this is implemented, all banks would move to the new system and this would help in better transmission of policy rates into lending rates. Then borrowers can look forward to lower EMIs on their loans. Also the Government is examining linking small savings interest rates to market interest rates, which will again lead to better transmission of rates to end users.

Disclaimer, Statutory Details & Risk Factors:

The views expressed here in this article / video are for general information and reading purpose only and do not constitute any guidelines and recommendations on any course of action to be followed by the reader. Quantum AMC / Quantum Mutual Fund is not guaranteeing / offering / communicating any indicative yield on investments made in the scheme(s). The views are not meant to serve as a professional guide / investment advice / intended to be an offer or solicitation for the purchase or sale of any financial product or instrument or mutual fund units for the reader. The article has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Whilst no action has been solicited based upon the information provided herein, due care has been taken to ensure that the facts are accurate and views given are fair and reasonable as on date. Readers of this article should rely on information/data arising out of their own investigations and advised to seek independent professional advice and arrive at an informed decision before making any investments. Please visit – www.quantumamc.com/disclaimer to read scheme specific risk factors.

Above article is authored by Quantum.

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