THE BUDGET proposals ensure a fall in borrowing costs for the government, but lending rates for individuals and corporates continue to stay elevated despite a 75-basis point cut in repo rate (the rate at which the RBI lends to the government) by the RBI over the last six months.
The Finance Ministry said it would borrow less this year, and pared its fiscal deficit target to 3.3 per cent of GDP, below the interim Budget estimate of 3.4 per cent of GDP. Besides, it also proposed to part-fund its deficit by tapping the international market.
The twin measures pulled the yield down on the government’s 10-year benchmark paper to a low of 6.54 per cent on Wednesday. The yield (coupon rate of the bond divided by its price) indicates the rate at which the government can borrow funds.
This disparity in interest cost between the Centre and other borrowers will make it difficult for both the demand in consumption to perk up and private investment to regain momentum. Most home and car loans are still priced above 9 per cent and those for small and medium enterprises are 10 per cent. This also points to the slow transmission of repo rate reductions into actual lending rates by banks. The 75-basis point reduction in policy rate by the RBI over the last three monetary policy committee (MPC) meetings in 2019 has resulted in banks cutting interest rates by only up to 20 basis points.
On top of this, increased risk premium following the NBFC crisis and an overall tight liquidity environment has also kept rates high. When asked about the divergence in interest rates for the government and non-government players, Finance Secretary Subhash Chandra Garg said deposits costs of the banks and risk premium of the borrowers are two important factors that influence bank lending rates.
“There are two additional factors which influence this: one, what is the cost of deposits of the banks and whether it has come down, and two, the risk premium which they attach to the borrower. So, it may be the case that deposit rates may have not come down and the risk perception on the borrowers has actually gone up slightly and we have seen this in the NBFC space. To my mind, possibly that is the reason why the spread has not come down,” Garg told The Indian Express in a recent interview.
What govt and RBI need to do
Behind high rates are multiple issues: slow transmission, tight liquidity, and high risk premium. The government has maintained fiscal discipline. It now has to infuse confidence in the industry, and the rest is for the RBI to manage.
“Overall the rates for them (retail, commercial borrowers) have also come down and spread has more or less been very stable and started showing some signs of declining after the initial months of the IL&FS crisis. Once these issues are addressed and the risk perception of the borrowers also (improves), then possibly we might actually see transmission,” he said.
Default on a series of debt papers by the IL&FS group starting last September and delay in repayments subsequently by certain NBFCs created liquidity stress in the financial markets. While the RBI and the government announced a number of steps to boost liquidity since then, the banks continue to be cagey about lending to risky borrowers and the risk premium has remained elevated. When asked on the issue of transmission of interest rates, RBI Governor Shaktikanta Das said in New Delhi on Monday that the central bank now expects a faster transmission. “In the last MPC meeting (June 6), I had said that by that time 50 basis points of repo rate cut had been announced, and out of this 21 basis points had been transmitted. And one positive thing that is happening now is, earlier it used to take six months for transmission, now the transmission is taking a much shorter period of two-three months,” he said.
Banks generally cut lending rates when either their borrowing costs drop or their profit margin goes up or the credit quality improves for the banks. In turn, the cost of deposit depends upon rise in deposits and good liquidity in the system. “While deposits have started growing, a bigger move will come when liquidity in the system increases and when that happens the lending rates for customers will fall,” said a debt fund manager with a leading fund house.