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The 25 basis points cut in RBI’s repo rate to 7.5 per cent was in line with expectations. It is the second this year after the 25 bps cut in January. While the move is welcome, the RBI’s hawkish tone was once again evident when it indicated limited headroom for further monetary easing.
The key for the industry will be the pass-through of this rate cut in the form of lower lending rates. When repo rate goes down, banks can obtain funds at a lower rate and thus pass the benefit on to customers. However, this can only happen if deposit rates can be re-priced efficiently to maintain the net interest margins of banks. But this appears difficult with the tight liquidity position of banks.
Still some way off
While the economic slowdown has constrained the overall credit growth at 16 per cent, according to data this month, deposits have grown at a slower 12 per cent. This has led to a squeeze on liquidity, with the credit-deposit ratio currently at 78 per cent.
The RBI, in its policy, has not done much to improve liquidity. The cash reserve ratio (CRR) remains unchanged at 4 per cent after the 25 bps cut in January.
Hence banks may not have much room to reduce their funding costs given their scramble for deposits. They also cannot immediately reduce lending rates as their funding costs remain high. The seasonal demand which sees the liquidity deteriorate in March, will ease by the first quarter of next fiscal and that may be the time when we see banks actually effecting cuts in their lending rates.
While the RBI has indicated that the liquidity deficit has remained above the indicative comfort zone, they will manage liquidity through various instruments, including open market operations (OMO). After the reduction in CRR in January, the RBI made open market purchases worth Rs 20,000 crore.
Inflation, a concern
While the RBI acknowledged the deceleration in growth, it continues to remain concerned about the divergence between wholesale and consumer price inflation. It also indicated that risks on account of the current account deficit (CAD) remain high, and will limit further easing of rates.
However, core inflation has moderated to 4 per cent, in line with RBI’s medium term inflation target. Also the Government’s resolve to keep fiscal deficit in check has also created some room for monetary easing by the RBI. This raises hopes that RBI will follow up with another round of rate cuts in May, after which it may evaluate its stance. Overall, another 25-50 basis points cut in repo rate can be expected in 2013.
Market reactions
While the rate cut was in line with market expectations, the political uncertainty emerging from DMK’s exit from the UPA Government and the RBI’s hawkish tone saw the bond market reacting negatively. The 10-year benchmark yield rose five basis points to an intra-day high of 7.93 per cent, and closed at 7.91 per cent. This has also been due to the rising uncertainty on the Government’s ability to follow through its fiscal consolidation target.
However, further rate cuts and continuous monetary easing through open market operations will continue to support the bond market and the yields should stabilise at lower levels.
>Radhika.merwin@thehindu.co.in
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