Home >industry >banking >RBI rate cut looks certain; all eyes on central bank guidance

Mumbai: Will Reserve Bank of India (RBI) governor Raghuram Rajan cut the repo rate on Tuesday? The answer is an overwhelming “yes" from bankers and economists.

All 10 banks Mint spoke to ahead of Tuesday’s monetary policy review expect Rajan to heed calls from both the government as well as industry to reduce the bank’s benchmark repo rate by 25 basis points (bps) to 7.25%, its third such reduction in 2015.

Repo, or repurchase rate, is the rate at which RBI lends funds to commercial banks. And, a basis point is one-hundredth of a percentage point.

Some of them even expect the central bank to reduce the statutory liquidity ratio (SLR), or the quantum of deposits banks have to mandatorily invest in government securities, from 21.5% to 21%, as it continues to nudge banks to lower borrowing rates and re-ignite credit growth.

Soumya Kanti Ghosh, chief economic adviser at State Bank of India (SBI), expects RBI to cut the repo rate by 25 bps, mainly to stoke demand in the economy.

“This is the right time for a rate cut. The demand side remains anaemic and it is expected to be so over the next few months. Moreover, inflation is expected to continue being on the downside for some time at least," Ghosh said, adding that he also expects a 50 bps cut in SLR, mainly because “easier liquidity is needed for hand-holding banks’ monetary transmission".

Transmission of interest rate cuts is a touchy subject for Rajan. In his last policy review in April, the governor lambasted banks for saying their cost of funding had not dropped despite a 50 bps cut by RBI in 2015 alone.

“Credit growth is tepid, banks are sitting on money and their marginal cost of funding has fallen. The notion that it hasn’t fallen is nonsense," Rajan said, adding that the “methodology doesn’t seem to stand in the way of banks raising base rates when interest rates (policy rates) are raised. It only seems to come in the way when interest rates are cut".

To push banks into reducing their lending rates soon after a policy rate cut, the central bank proposed changing the way they calculate their minimum lending rate or base rate. Earlier, banks used to calculate the base rate on the average cost of deposits. Now they are being encouraged to calculate the base rate taking into account the marginal cost of funds.

Some bankers like Arundhati Bhattacharya, chairperson of SBI, have expressed reservations on how this will work, saying that repricing of the entire asset base will have to go through a long transition period.

“When the rates go down, depositors will start getting much less. When rates go up, borrowers will have to pay much more. How to balance all of it is what we have to see," Bhattacharya said.

Indian banks have reluctantly cut their benchmark base rates, or the minimum rate at which they lend, by 15-25 bps since the last policy review in April.

Indranil Sengupta, chief India economist at Bank of America-Merrill Lynch, said it is more likely that another rate cut by RBI will lead to more tangible outcomes in terms of lower rates. “Banks can be expected to reduce their base rates by 25 basis points simply because this is a lean season and credit growth is weak so there is no pressure on bank earnings," Sengupta said, adding that he expects RBI to cut repo rate by 25 basis points mainly because of lower inflation.

Consumer price inflation has come off a peak of 8.48% a year ago to 4.87% in April, well within RBI’s 6% target for 2016.

Upasna Bhardwaj, an economist at Kotak Mahindra Bank Ltd, said an SLR cut is also likely as RBI aims to push banks to lend to productive sectors. “Though a reduction in the cash reserve ratio will be preferred by banks to provide liquidity, transmission is more likely this time. Banks may reduce their base rate by about 25 basis points," Bhardwaj said.

However, more than the interest rate move by RBI, traders will be watching for what the central bank says on its future interest rate moves.

“Though everyone expects a 25 bps cut, there is also talk that this may be the last cut in the current cycle, which is why the guidance is being keenly watched—particularly for what RBI says on the monsoon. Whether it says that a normal monsoon will lead to further cuts or whether it flags risks linked to monsoon uncertainty will be watched," said Hitendra Dave, managing director and head of global markets for India at Hong Kong and Shanghai Banking Corp. Ltd.

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