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Wednesday, October 27, 2021

Simply put: The cut, and likely thrust to demand

RBI surprised the markets with a higher-than-expected rate cut of 50 basis points on Tuesday, boosting sentiment and fuelling hope of a revival in demand. SHAJI VIKRAMAN explains the Bank’s decisions.

Written by Shaji Vikraman |
Updated: December 26, 2015 12:10:44 am
RBI, RBI, repo rate, rate cut, emi, RBI rate cut, loans, cheaper loans, Raguhram rajan, Rajan rate cut, 50 bps rate cut, rbi cut, cheaper loans, india rbi RBI Governor Raghuram Rajan.

How does a repo cut help?

Repo rate is the rate at which the RBI provides funds to banks. A lowering of this rate should translate into lower cost of borrowings for banks, but lenders have argued that with deposit rates being sticky, it would be difficult to reduce interest rates.The other contention is that rates on small savings schemes such as Public Provident Fund (PPF), post office savings schemes, and provident fund or retirement schemes is way higher than that offered by banks on term deposits, making it tough for them to reduce deposit rates. And banks need such term deposits to boost their lending. But a cut of 50 basis points will help retail customers or individuals lower their cost of borrowing when they buy a home, automobiles, consumer durables or other assets. Similarily, for corporates or firms, this will lead to lower interest outgo on their borrowings. Broadly, it should help boost demand, with gains for both individuals and companies, which in turn should reflect in higher revenues for firms and for the government — and perhaps more jobs too, as demand picks up and factories raise their output. For the government, the biggest borrower, it will mean raising funds at a lower cost.

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How does this benefit banks?

With lower rates, as the demand for loans picks up, the income of banks and their earnings will be boosted. Loan growth for banks in India was at a two-decade low at last count. With a pile of bad loans on their books, banks should gain this time, as a half per cent rate cut will signal improved treasury gains for them. What this means is that they will book gains on bonds that they had subscribed in the past at higher interest rates, as investors buy those bonds, with interest rates sliding. These gains can be used to set aside money for providing against bad loans, or for the mandatory norm of apportioning capital against the risk of loans going bad.

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What happens now? How will the impact of the rate cut play out?

Banks should be reducing deposit rates further on term deposits. But expect the government to soon lower the high rates — averaging well over 8.25% — on small savings schemes. These rates are way above the mean average rate, and which banks complain prevent them from cutting their rates aggressively. The RBI has said that it will work with the government on transmission — or ensuring that the benefits of a lower policy rate filter down. Corporates with debt contracted at high levels can negotiate with their lenders for refinancing at lower rates.

The RBI has said it would allow foreign investors to buy more government bonds or securities. How will that help?

Foreign funds or portfolio investors are allowed to buy both government bonds and bonds and securities issued by corporates. There is plenty of demand from this set of investors, who want to stock up on sovereign paper as it is called — be it treasury bills or government securities of various maturities. This should open up an additional investor base for the issuer — the government and the RBI, which in the past have been wary of allowing foreigners to hold more of sovereign debt. India has been conservative on this. But where this helps is in keeping rates stable, as higher demand will reflect in competitive prices. And this time, with a separate limit for foreign investors who want to buy state development loans or securities issued by state governments, governments of better performing states should be able to borrow at cheaper rates.

How will the issuance of rupee denominated bonds by Indian corporates overseas help?

For Indian companies, it is tempting to borrow abroad now — with average rates a little over 2% in many markets, compared to the close-to-double-digits for top companies in India, and higher for the next rung of companies. But attractive as it is, borrowings abroad carry the risk of currency fluctuation. A sharp swing can damage the balance sheets of companies — especially those without the comfort of export earnings that can offset this. That is why a rupee denominated bond in an overseas market transfers the risk to the investor rather than the borrower. The key will be the reputation and performance of the issuer of such bonds. In the long term, this should also help in the internationalisation of the rupee. China has its set of bonds — the renminbi bonds.

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