4 min read.Updated: 08 Apr 2015, 12:51 AM ISTAnup Roy
The central bank said it would wait for banks to pass on rate cuts that have already been announced before it looks for further easing
Mumbai: The Reserve Bank of India (RBI), in its first bi-monthly monetary policy for fiscal 2015-16, kept the policy rate unchanged at 7.5%, but initiated tough measures to force adamant banks to bring down their lending rates.
“It is a status quo on policy, but not a status quo on other policy paths," RBI governor Raghuram Rajan said in a post-policy interaction with the media.
The central bank said it would wait for banks to pass on rate cuts that have already been announced before it looks for further easing.
To force banks to bring down their lending rates, the central bank changed how lenders calculate their minimum lending rate, or base rate. Earlier, banks used to calculate base rate on average cost of deposit basis, now banks will have to calculate the base rate taking into account marginal cost of funds.
This is important because with every policy rate action, money market rates move. Banks borrow from the money markets as well and their incremental cost of funds changes. However, on an average basis, the change is not significant and banks don’t pass on the rate benefit to the customer.
“For monetary transmission to occur, lending rates have to be sensitive to the policy rate," RBI said in its policy statement, adding base rates based on marginal cost of funds should be more sensitive to changes in the policy rates.
In the post-policy interaction, Rajan said the banks’ logic that cost of funds has not come down enough to reflect on their base rate is “nonsense". Cost of funds has come down but banks are not passing it on to their customers, the governor said. The governor lambasted the banks for taking refuge in the methodology of base rate calculation as a way to justify not cutting rates.
“Base rates don’t stand in the way when interest (policy) rates are raised, but they seem to come in the way when interest rates are cut," said Rajan.
“In the absence of credit growth, banks are sitting on cash without passing on a rate benefit. If you are able to raise deposits at a lower rate, it should get transmitted. Instead of average cost of funds, the reference point is money market rates, we can move there quickly," said Rajan.
However, he also said since the companies are raising funds at a cheaper rate from the market and do not need loans, banks will be forced to bring down lending rate because of the competition.
RBI had unexpectedly reduced the policy rate by 25 basis points on 4 March—the second such cut outside a scheduled monetary policy review since January. The first rate cut of the cycle had been announced on 15 January. One basis point is one-hundredth of a percentage point.
“Going forward, the accommodative stance of monetary policy will be maintained, but monetary policy actions will be conditioned by incoming data. First, the Reserve Bank will await the transmission by banks of its front-loaded rate reductions in January and February into their lending rates. Second, developments in sectoral prices, especially those of food, will be monitored, as will the effects of recent weather disturbances and the likely strength of the monsoon, as the Reserve Bank stays vigilant to any threats to the disinflation that is underway," said RBI explaining its stance.
The target for consumer inflation has been set at 6% by January 2016, according to the monetary policy framework agreement between the government and the central bank. “CPI inflation is projected at its current levels in the first quarter of 2015-16, moderating thereafter to around 4% by August but firming up to reach 5.8% by the end of the year," RBI said in its statement.
Economic growth for the new fiscal is expected at 7.8%.
“Assuming a normal monsoon, continuation of the cyclical upturn in a supportive policy environment, and no major structural change or supply shocks, output growth for 2015-16 is projected at 7.8%, higher 30 bps from 7.5% in 2014-15, but with a downward bias to reflect the still subdued indicators of economic activity," RBI said in its policy statement.
Consumer price-based inflation inched up marginally to 5.37% in February from 5.19% in January, while wholesale price-based inflation hit a negative 2.06% in February.
After the latest review, the repo rate—the rate at which the central bank infuses liquidity into the system—remains at 7.5%. The cash reserve ratio (CRR), or the portion of a bank’s money maintained with the central bank in cash, remained at 4%.
In a Bloomberg poll, 33 of the 42 analysts had expected rates to remain unchanged.
At 11.55am, 10-year bond yields rose to 7.776% from 7.726% before the policy. The Sensex, the benchmark equity index of BSE, was down 0.08% to 28,465.25 points. Before the policy, the Sensex was trading at 28,508.38 points.
RBI’s easier monetary policy is yet to transmit through the system.
Barring a few smaller banks, most lenders have not passed on the benefit of rate cuts to their customers. Bankers have, however, indicated that rates could come down early this fiscal year.
Subscribe to Mint Newsletters
* Enter a valid email
* Thank you for subscribing to our newsletter.
Never miss a story! Stay connected and informed with Mint.
our App Now!!