Business News/ Politics / Policy/  Huge inflow of liquidity after cash curbs raises RBI rate cut hopes

Expectations of an interest rate cut by the Reserve Bank of India (RBI) have surged since the government decided to withdraw high-value banknotes in a crackdown on unaccounted wealth.

A huge inflow of liquidity into the system because of the currency demonetization has already translated into a cut in deposit rates and money market rates. Some economists say that demonetization is disinflationary and coupled with its near-term disruption to economic growth, a rate cut is in the offing.

“Right now, there is more than a 50% chance of a rate cut in December. The RBI might want to make the reverse repo cheaper since banks will be parking the additional liquidity there," said Gaurav Kapur, an independent economist.

According to data available with the banking sector regulator, banks have been able to garner deposits worth Rs5.12 trillion between 10-18 November. Withdrawals were only a fifth at Rs1.03 trillion.

At the end of Friday, banks have parked Rs3.2 trillion with the RBI under its reverse repo facility, Bloomberg data showed.

In its last monetary policy announcement on 4 October, RBI had reduced its repo rate, the rate at which it lends to banks, by 25 bps, bringing it down to 6.25%. Thus the reverse repo rate stayed at 5.75%. One basis point is one-hundredth of a percentage point.

S.K. Ghosh, chief economic adviser at State Bank of India (SBI), had expected a 25-50 bps rate cut for the rest of the financial year even before the government’s demonetization drive was announced.

“After demonetisation was announced, the expectation of a rate cut of over 25 bps has gotten even stronger. Banks will be reducing their lending rates as the deposit rates keep falling. Once the RBI repo rate is cut, the transmission will be even faster," Ghosh said.

Since 8 October, 10-year bond yields have dropped nearly 36 basis points (bps), while short-term rates have dropped 30-40 bps.

The fall in short-term rates have also prompted lenders such as SBI, ICICI Bank Ltd, HDFC Bank Ltd and Canara Bank Ltd to reduce their deposit rates. Private sector lender Axis Bank had reduced its marginal cost lending rate (MCLR) by 5 bps across various loan tenors.

In a report released on 16 November, HSBC Research pointed out that the low inflation impact may not show up immediately because of supply disruptions. Anecdotal evidence suggests that agriculture food procurement, which largely runs on cash, has been hit in recent days, HSBC said in its report.

As remonetization gathers pace, some of the supply-side disruptions could be repaired, the report added.

“Lower growth and lower inflation over the next year are supportive of our 25bp repo rate cut call for the remainder of the fiscal year," HSBC economists Pranjul Bhandari and Dhiraj Nim said in their report.

There are others who feel that the cumulative impact of lower money market rates and falling deposit rates will be enough to ensure transmission in the system, making an RBI-led rate cut unnecessary.

“While a (US) Fed rate hike later in December has been mostly discounted by markets, near term uncertainty on the domestic economy has risen," said Saugata Bhattacharya, chief economist at Axis Bank.

“We are unsure about the breadth, magnitude and duration of a growth slowdown as well as potential for lower inflation following the currency withdrawal. At the same time, the rise in banking liquidity is already translating into a cut in deposit rates, and for one bank, a cut in lending rates. Also, the rupee’s depreciation will act like an additional stimulus," Bhattacharya added.

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Updated: 22 Nov 2016, 04:08 AM IST
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