BackMonetary transmission: Will reduction in small savings rate help?
Rather than the lower rates on small savings schemes, the switch-over to a new marginal cost of lending rule may then deliver the desired result
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Expectations of a lower interest rate regime are high following the reduction in government-managed interest rates of various small savings schemes. The cut was in the range of 40-130 basis points across different tenors. Interest rate setting will be quarterly henceforth instead of annual reviews earlier for a better alignment with other interest rates, especially the benchmark 10-year bond yield. One basis point is one-hundredth of a percentage point. As the interest rate difference between small savings and bank deposits impacts portfolio choices of the savers, a narrowing gap implies that banks now have more flexibility to adjust their base rates, which have been quite sticky. Monetary policy transmission is now expected to pick up in magnitude as well as speed. Absorbing this development, and anticipating further reinforcement from the central bank in the form of a policy rate cut soon, bond yields have softened and all look forward to an easier interest rate regime when the new financial year starts.
Whether banks pass through monetary policy signals fully after the pruning of governed interest rates may not necessarily follow as corollary though. Lending rates may well be lower ahead, but that could also come from another impending rule change to marginal cost pricing of loans. It may be hard to disentangle the two effects, so it might be difficult to conclude as to what obstructed monetary transmission to start with. Bank behaviour in the recent two years has been especially contrary to past, exhibited trends in this regard. The accompanying chart reflects the historically asymmetric responses of banks to monetary policy signalling. Tightening cues are picked up quickly and fully as seen in the 2004-08 and 2010-11 cycles, while downward adjustments in response to monetary easing (2008-09 and 2012-13) have been correspondingly sluggish.
But more than two years ago, when the Reserve Bank of India (RBI) unexpectedly tightened by 75 basis points in three steps over September 2013-January 2014, banks barely budged even to the upside in response. On average, base rates rose just 10 basis points, notwithstanding the far stronger increase in the reference 10-year bond yield reflected in the chart. In fact, banks have been arguably more responsive in the easing cycle thereafter. Again, this is contrary to characteristics exhibited in the past.
The reasons for the deviation in banks’ responses to monetary policy cues probably lie in the economic conditions and related balance sheet stress–their own as well as those of their borrowers — that are manifest in the unrelenting, systematic increase in non-performing assets as loans have increasingly turned sour. If that indeed is the case, then banks may still prefer to look at their balance sheets, currently in the thick of an aggressive clean-up phase. Rather than the lower rates on small savings schemes, the switch-over to a new marginal cost of lending rule may then deliver the desired result.
Renu Kohli is a New Delhi based economist.
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