Opinion | 110 bps cut later, transmission is the key now2 min read . Updated: 08 Aug 2019, 12:02 AM IST
RBI has infused liquidity in the banking system, which is currently in surplus
Come any monetary policy review by the Reserve Bank of India (RBI), and all eyes are on the “action" on policy rate, like the climax of a movie. This is because the repo rate is the pivot that moves interest rates across the economy. RBI’s monetary policy committee (MPC) reduced the repo rate from 5.75% to 5.4%. It is the rate at which banks avail of liquidity from RBI, when required. The repo rate is the starting point of the needle of interest rates in the economy. When RBI wants interest rates to come down, MPC reduces the repo rate.
Currently, inflation in our economy is much on the lower side compared to historical standards and there are concerns on sluggish GDP growth. This is the perfect recipe for RBI to ease rates and give impetus to the economy. Globally, central banks are easing policy rates—their repo or equivalent rate—which is a conducive factor for RBI. When money is available at relatively cheaper rates, there is all the more reason for entrepreneurs to avail of loans and build capacities. It also makes it easier for individuals to avail of housing, personal or other loans, as EMIs are lower, which incentivizes consumption. This, in turn, propels production of those goods and services and, hence, the economy.
Where do we go from here? There is scope for further rate cut(s) by RBI, due to the reasons mentioned earlier. Since the new RBI governor took over, MPC has been supportive of giving a push to growth. Conventionally, policy rate action happens 25 basis points (0.25%) at a time; Wednesday’s rate action of 35 basis points is a pointer to the fact that the approach of MPC is accommodative; in other words, it is biased towards easing of rates. Over the last two decades, RBI repo rate has dipped meaningfully below 6% only twice; this is happening now due to the current inflation-growth combo.
However, one crucial factor from now on is the transmission of the 110 basis points rate cut already done this year to the real economy. Here, real economy means the rates on loans charged by banks to you and me. On fresh loans, banks have reduced their lending rates by only 29 basis points in the current phase. Banks base their fresh loan rates on the marginal cost of funds-based lending rate (MCLR), which is a function of fresh deposits, as distinct from historical deposit rates. On its part, RBI has infused liquidity in the banking system, which is currently in surplus. It is expected that the lower signal rate and easy banking system liquidity would gradually percolate to real rates, and serve the purpose. RBI has constituted a Working Group on the Liquidity Framework, which will submit its report in some time. This will give a better perspective on RBI’s view about maintaining liquidity surplus in the banking system which, in turn, will give a clue to transmission.
For your investments in bonds or bond funds, it is advisable to execute fresh investments for shorter maturity, say up to three or four years. For longer duration products, while there is scope for further easing of yields (or higher prices), the upside is limited. A significant rally—by 1%—in government bonds has already happened over the last few months.
Joydeep Sen is founder, wiseinvestor.in