May 03, 2013 06:27 PM IST | Source:

Sorry Chidu, rate cut doesn't often mean cheaper money

Given the economy's continuing slide, the Reserve Bank of India (RBI) did the expected 25 basis points (bps) cut in the repo rate, despite fretting a lot about potential inflation.

R Jagannathan

Given the economy's continuing slide, the Reserve Bank of India (RBI) did the expected 25 basis points (bps) cut in the repo rate, despite fretting a lot about potential inflation.

As the repo rate - the rate at which the RBI lends overnight money to banks - signals Governor D Subbarao’s overall assessment of where the cost of money should be heading, we can take it that borrowing costs should start coming down. This should please the Finance Minister, who has been a votary of cheap money ever since he returned to North Block last August.

But here’s an eye-opener. The RBI may cut rates, but banks are not buying the idea.

An interesting bit of statistic from Subbarao's Monetary Policy Statement for 2013-14, announced today, shows that banks are playing Scrooge. They have held on to most of the gains coming to them from monetary easing during the whole of 2012-13.

In the year to March 2013, the Reserve Bank cut the repo rate by 1 percent (over several months), the cash reserve ratio (CRR) by 75 basis points (0.75 percent), and the statutory liquidity ratio by 1 percent. This means, every bank got additional resources of at least 1.75 percent, apart from the 1 percent repo cut – which operates only when overnight money is borrowed from the RBI.

Put another way, banks that borrowed continuously from the repo window got a 2.75 percent easing, while those who borrowed less or nothing from the RBI got 1.75 percent.

No doubt, many borrowers benefited from the subsequent easing of lending rates.

Many does not mean most. Guess how much of this gain banks really passed on? Just  39 basis points (where 100 bps make 1 percent).

Hear what the RBI says on this: “In consonance with the cuts in the policy repo rate and the cash reserve ratio (CRR) during 2012-13, the modal term deposit rate declined by 11 basis points (bps) and the modal base rate by 50 bps. While the decline in the term deposit rate occurred mostly during the first half, the modal base rate softened by 50 bps to 10.25 percent in two steps of 25 bps each during Q1 and Q4 of 2012-13. During Q4, 39 banks reduced their base rates in the range of 5-75 bps. The weighted average lending rate of banks declined by 36 bps to 12.17 per cent during 2012-13 (up to February).”

Even assuming banks cut their weighted rates further during March, when the RBI announced the last repo rate cut, the total gain to borrowers would be less than 0.5 percent on the outside.

To belabour the point again: a year’s worth of reduction in fund costs and monetary easing by 1.75-2.75  percent (varying from bank to bank), gave borrowers a net gain of only 0.39 percent (39 basis points) up to February. In short, banks swallowed most of the monetary gains.

No doubt, banks have their own reasons for keeping borrowers out of the party. Their soaring bad loans and lack of business growth may have forced them to fleece existing customers more. Especially middle and small enterprises, who create the most jobs, and who are most in need of bank money.

But the big takeout is this: the FM may think rate cuts are what will boost investment, he may even pressure the RBI to toe his line, but he cannot get banks to play ball when they feel beleaguered. He cannot get even companies to borrow more to invest in new projects when the prospects for the economy are still poor.

As the monetary policy statement notes, businessmen are still not investing, and consumers have begun holding back – a vicious cycle of de-growth. The RBI said: “On the demand side, the persisting decline in capital goods production during April 2012–February 2013 reflects depressed investment conditions. The moderation in corporate sales and weakening consumer confidence suggest that the slowdown could be spreading to consumption spending.”

At another level, it is Chidambaram’s fiscal cuts – which are absolutely necessary to rein in overspending – that are accentuating the problem in the short run.

The RBI said: “Liquidity remained under pressure throughout the year because of persistently high government cash balances with the Reserve Bank and elevated incremental credit to deposit ratio for much of the year.”

In simple terms this is what it means. When government maintains “persistently high” cash balances with the RBI, it means it is not spending its tax revenues. When government does not spend, money that should be flowing back into the economy and stimulating growth stays bottled up.

But it is also worth pointing out this irony. Just because the government keeps spare cash with the RBI does not mean it does not owe others money. For example, the diesel, kerosene and LPG subsidies due to the oil companies for last year has still not been paid. Thus the spare cash with the RBI is not really spare cash, but partly money owed as subsidies.

Macroeconomically, restraining spending is the right thing to do, but it also means that the growth cycle will take some time to rebound.

This is why the RBI’s GDP growth projection for 2013-14 is 5.7 percent, even as  the PM’s Economic Advisory Council is talking of 6.4 percent.

Only time will tell who is more right. But one thing is certain: the FM cannot pretend that interest rate cuts alone will revive growth. Or even that they will percolate down to the sectors most in need of credit.

This is the hidden message in the monetary policy for 2013-14.

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