Ever since Reserve Bank of India deputy governor Subir Gokarn hinted that there is now more elbow room to cut policy rates thanks to lower global crude oil prices and weakening core inflation, hopes have been running high in the financial markets.
The Indian central bank will announce its next policy move later this month. But a reduction in policy rates may not necessarily bring down the cost of capital for Indian companies.
To understand why, take a look at the rates of growth in bank deposits and bank credit. The latest data from the RBI shows that as on 18 May, aggregate deposits were up 13.8% over a year ago while aggregate credit was up 17.4%. Banks have been covering this gap by either selling their excess holdings of government securities or looking at non-deposit sources of finance such as certificated of deposits, which have seen a surge of issuance in recent months.
The stress in the domestic money market has been structural, thanks to the wide gap between deposit and loan growth. What had added to the stress is the fact that Indian companies are looking at rupee loans thanks to deleveraging by European banks.
It is to be seen whether the RBI actually shifts its attention from inflation control to supporting growth, especially after the recent data showed that the Indian economy recorded its slowest quarterly growth rate in nine years during the fourth quarter of FY2012. Some Indian banks seem to be anticipating such as event. On Thursday, for example, State Bank of India, the country’s largest bank, decided to reduce its retail term deposit interest rates by 0.25% for deposit tenors up to 240 days, correcting the sharp increases it made last year. SBI left lending rates unchanged.
In case RBI does cut rates, do not count on banks following with quick reductions in their lending rates.