MUMBAI: Less than a week after the Union Budget, RBI governor Raghuram Rajan on Wednesday reduced the repo rate – the rate at which RBI lends to banks – by 25 basis points to 7.5%, citing improved government finances.
However, the burden of home and auto loans on borrowers is expected to ease only in April. This is RBI’s second rate cut in as many months but only three out of 45 banks – Union Bank, United Bank and Karur Vysya – have so far lowered the benchmark rates, while the others have pocketed the gains at the cost of borrowers.
Although banks have seen a marginal dip in cost of funds, they are refusing to lower rates immediately due to earning pressure on account of rising bad loans. This is also the second time the central bank has cut rates outside its scheduled reviews to boost investment and growth.
READ ALSO: Market ends 213 points down but rally likely to continue
“Transmission of the rate cut this month is a toss-up . It may not happen in March but will happen in the new financial year and the extent of transmission may not be the same,” said Arundhati Bhattacharya, chairman, State Bank of India. “Year-end cuts in deposit rates would impact business while a cut in loan rate now will impact income,” she added.
Interest rates on a large number of loans would be lowered in March and an immediate rate cut would bring down interest income for banks. Also, the year-end is the time when banks try to beef up their balance sheet by aggressively mobilizing deposits and often offer better deals.
Explaining the rationale behind the rate cut Rajan said that improvement in the government’s finances was better than what headline numbers revealed. “The government is transferring a significantly larger amount to the states, without entirely devolving responsibility for funding central programmes. To the extent that state budget deficits narrow, the general fiscal deficit will be lower. Furthermore, supported by lower international energy prices, there is a welcome intent to shift from spending on subsidies to spending on infrastructure, and to better target and further reduce subsidies through direct transfers,” said Rajan in a statement announcing the rate cut.
After the February 28 budget, the government had fired on all cylinders to highlight its efforts to repair finances and had said that the ground had been laid for a cut in interest rates. The government hopes that moderating rates will help fuel consumption and help accelerate growth. But transmission of the first rate cut to lending rates by banks has so far been patchy.
READ ALSO: Pressure of 2 rate cuts to feed into lower rates over time: Raghuram Rajan
Bank stocks gained immediately after the rate cut announcement but fell back in line with the Sensex which retraced all the gains it made during the day. The yield on the benchmark 10-year bond fell to a 20-month low of 7.61% after Rajan said that he was confident that inflation would remain contained.
Although some economists did forecast a rate cut given the improvement in the quality of fiscal deficit in the budget, the timing of the rate cut took markets by surprise. Besides announcing the move mid-week, this was also the first time that RBI announced its measures before markets opened for trading.
Banks are yet to pass on the benefits of the earlier mid-term cut in interest rates announced by RBI on January 15. “Since there is a lag effect for the monetary transmission to take place, effect of previous 25 basis points cut together with the present rate cut would encourage banks to review their base rates,” said TM Bhasin, chairman, Indian Bank and chief of the Indian Banks Association.
In a post policy conference call with analysts Rajan said he expects transmissions of the monetary policy to take place in the next financial year.
