The main reason why markets and finance ministry are clamouring for the RBI to cut policy rate is the assumption that the move will automatically lead to banks lowering their lending rates.
The main reason why markets and finance ministry are clamouring for the RBI to cut policy rate is the assumption that the move will automatically lead to banks lowering their lending rates. This in turn should boost demand for loans and revive growth in the economy. At least, in theory.
But analysts at brokerage firms Morgan Stanley and Bank of America Merrill feel there is unlikely to be a meaningful drop in banks’ lending rates. That is because banks are already struggling to raise deposits despite offering high interest rates. For banks to be able to drop lending rates, they should also be in a position to cut deposit rates to maintain their profit margins.
But that may not be easy. This despite India being among the few countries where interest rates are ruling close to the peak levels in 2008 just before the global financial crisis.
Extracts from the Morgan Stanley report authored by Anil Agarwal, Sumeet Kariwala and Subramanian Iyer
"We believe that it will be tough for banks to cut deposit rates meaningfully given the elevated loan-to-deposit (LD) ratio. Deposit growth in India has persistently stayed below loan growth, thereby taking the LD ratio to over 77%. In fact, in the entire economic slowdown over last few quarters – LD ratio has actually moved up, an unusual outcome in a slowing economy.”
And why exactly are banks struggling to raise deposits?
"Various reasons have been cited for this. Individuals investing in real assets, weak corporate profitability etc. The key reason, in our view, is the fact that real deposit rates (adjusted for consumer price index) are negative. Banks will not get a pick-up in deposit growth unless real rates rise," write the trio.
Bank of America Merrill economist Indranil Sen Gupta too is of the view that banks will not be able to cut their rates in a big way even if RBI were to cut the policy rate.
An extract from the BoA Merrill report:
"Can banks cut lending rates if liquidity remains as tight as it is now? Not really. It is for this reason we expect the RBI to buy gilts by an additional Rs 32000 crore through Open Market Operations by March. Although high lending rates are hurting growth, they are not coming down because the USD 35 billion of RBI forex intervention has pulled down deposit growth even further."