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RBI’s 25 BPS Repo Rate Cut & Its Implications: Banks In A Catch-22 Situation

The Reserve Bank of India has cut repo rate by 25 bps to six percent from 6.25 percent. Loans are therefore set to become cheaper. The reverse repo rate has also been reduced by 25 bps to 5.75 percent from six percent. Repo rate is the rate at which the central bank lends money to banks. The move comes at a time when inflation is well below the target for the consecutive quarters. The key rates were last slashed in October 2016. The new six percent rate is the lowest since November 2010.

RBI governor said post the policy change that there is scope for banks to reduce lending rates. This was a cue to commercial banks for passing on the rate cut to consumers. There has been a significant moderation in retail inflation in the past three months and that called for more easing of monetary policy from the RBI. On Wednesday, the central bank once again made it clear that it will retain its neutral stance, the same stance it had taken at the beginning of the year.

Prime Minister’s demonetisation drive resulted in weak consumer spending. Coupled with it, lower food prices also kept inflation below the central bank’s four percent mid-term target for the past eight months. The Indian economy was growing at its slowest pace in over two years. Hence, the RBI provided a booster shot, made possible by the slumping inflation. However, the recent repo rate cut of 25 bps was not a unanimous decision. One voted for a 50 bps cut, another suggested no cut and four members voted for the 25 bps cut.

Now, the RBI is expected to remain status quo at least till 2019 as economic growth will accelerate as per a Reuters poll. Indian stocks are also trading at a record high. However, the possibility of another rate cut remains if inflation remains in the lower territories. If banks pass on the rate cut to consumers, it will only happen over time. As is evident, their margins are already under tremendous pressure. On Monday, the State Bank of India slashed interest rates on savings bank accounts to 3.5 percent from four percent on balance of one crore or below.

Many are calling this a Catch-22 situation for banks as not only margins are a concern but also loan growth is still weak. Hence, they would be under pressure to pass on any rate cut. SBI has also slashed the marginal cost of funds based lending rate (MCLR) by 90 bps from Jan. 1, reports The Times of India.

“There has been significant outflow of CASA (current account and savings account) deposits. The revision in savings bank rate would enable the bank to maintain MCLR at the existing rates, benefitting a large segment of retail borrowers in SME, agriculture and affordable housing segments,” the SBI had said earlier.

The growth forecast for the country remains unchanged for the current fiscal at 7.3 percent. Thus, the country may soon reclaim its position as the fastest growing major global economy. GST is also expected to add two percent to the country’s GDP.

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