Unpredictable rate cut but the signal is clear

Both the RBI and the central government should see that the transmission of the rate reduction by the banks happens soon, otherwise the whole exercise is futile, says Subramanian MV.

Reserve Bank of India governor Raghuram Rajan cut the REPO rate by a larger margin than the market expected, but it is a welcome step going forward, to bring in accelerated growth in the economy. If not done we would have the run the risk of getting into a stagflation stage of the economic cycle, keeping in view the all-round poor economic growth in all the countries except India and the US. Even China, which till recently was the fastest growing economy, has slowed down.

Though RBI under the present governor had been emphasising that the core role of the central bank is inflation targeting and that the interest rates movement is not the only tool in monetary policy management -- most of the borrowers in the market look for the direction of the interest rate movements.

Most importantly, both the RBI and the central government should see that the transmission of this rate reduction by the banks happens soon, otherwise the whole exercise is futile. Banks have given various excuses for not reducing the base rates as and when the repo rates have come down, but when the RBI announced a different approach for base rate calculation based on marginal cost of funds, there is so much critical comments from the bankers’ side. The final guidelines, likely to be announced by November end,  will clarify this issue and that would provide a transparent approach for base rate fixing and the transmission of the RBI’s

The rate reduction and the subsequent transmission will ultimately benefit retail as well as corporate customers; home loan/car loan EMIs will come down and working capital loans for SMEs, MSMEs and other corporate will come down. At the same time, the depositors of fixed deposits with banks will lose out but that is inevitable, if the interest rate cycle is itself moving downwards.

In tune with the rate cut and the noise the commercial banks would make on the public deposits schemes like PPF, NSCs and other post office FDS, the government should look into the interest rates of these schemes and rationalise them with immediate effect. The government can continue to provide some relief for senior citizens for special deposit schemes as hitherto.

India’s interest rates are the highest in the world and with the integrated financial markets all over the world, we cannot continue to have very high interest rate and a declining inflation. Our banks’ SLR requirement is also unique when compared to global banks and very soon we need to align with the world market rates. With Basel recommendation to be uniformly applied by all the banks, the SLR structure will undergo a definite change in the next five years and the RBI had started declining the SLR requirements over the past years and in future.

The interest rate reduction will soon kickstart the economy which is not growing as per the government’s expectation and even in the current expectation of the RBI, the growth is like to be at 7.4 per cent this year and with the emerging markets growing at a lower rates, the signal of slowing interest rates cycle augurs well for the future.

Subramanian MV is a retired banker.