Much drama has come to accompany the bi-monthly meetings of India’s monetary policy committee (MPC) to fix the repo rate, the rate at which banks borrow short-term money from the RBI. Before each policy meeting, captains of industry beseech the MPC to deliver a rate cut that can lift the economy out of its funk. After it, experts weigh in on the deep significance of the cut and scour the policy statement for hawkish or dovish tendencies.
But this drama underplays the fact that, in the last three years, the MPC’s repo rate changes have had very limited impact on the borrowers, savers and investors in the Indian economy.
Small cuts for borrowers
Consider bank borrowers first. Between January 2015 and now, the MPC unleashed two big rate-cutting sprees. In the first that started off in January 2015 and ended in August 2017, it slashed the rate by 200 basis points from 8 to 6 per cent. But banks trimmed their base rates (floor rates at which they lend) by 75-100 bps, effectively passing on only 50-60 per cent of the cut to borrowers.
After pausing awhile, the MPC again pruned the repo rate by 75 bps between February and July 2019 (excluding the latest cut). But this time around, banks’ lending rates (now the MCLR) fell by just 15-35 bps, transmitting less than half of the repo cuts to borrowers. Only a part of these MCLR cuts, in turn, will be passed on to retail or business borrowers.
For one, many legacy loans continue to be priced at the old base rates, while the new MCLRs apply only to loans since 2016. Banks’ base rates have fallen much less than the MCLR, correcting by just 85-100 bps since January 2015. Two, banks fix spreads to compensate for the individual borrower’s risk profile, over and the above the official MCLR or base rate.
In effect, though the repo rate may have seen a 225-bps reduction since January 2015, bank borrowers may have seen their effective loan rates fall by less than 100 bps.
The Indian government, the largest borrower in the market, is in the same boat too. In January 2015, with the repo rate at 8 per cent, it used to borrow 10-year money at 7.9 per cent. Today, with the repo rate at 5.40 per cent, its 10-year borrowing costs are a 100 bps higher than the repo, at 6.4 per cent.
Earlier, the RBI used to carefully orchestrate the government’s borrowing costs through its government security (g-sec) auctions. But post-demonetisation, its ability to play piper has weakened. As a deluge of deposits after the note ban saddled banks with huge excess SLR, banks have turned half-hearted buyers of g-secs in the last three years.
With a chronic over-supply of g-secs in the market, their yields now react more to demand-supply factors. Today, g-sec yields react more to news on the size of the fiscal deficit, the government borrowing calendar and bank/FPI/mutual fund participation, than MPC actions.
No hold on markets
The MPC’s pruning of rates hasn’t impacted borrowing costs for companies or NBFCs in the bond market either. With defaults by top-rated borrowers and a brewing NBFC crisis, since August 2018 Indian bond buyers have sharply pegged up the risk premiums that they demand from all non-government borrowers. As a result, AAA-rated corporates who used to borrow at 70-80 bps above the g-sec rate until mid-2018 now pay 120 bps more. AA-rated firms pay 190 bps over the g-sec rate, while A- or BBB-rated ones, though theoretically investment-grade, pay a steep 400-500 bps more. Between 2015 and now, blue-chip companies’ market borrowing costs have seen a marginal fall from about 8.5 to 8 per cent. For the majority of business borrowers, the costs have spiked.
With MPC actions playing a limited role in deciding either the quantum or direction of domestic interest rates, returns for India’s bond market investors increasingly depend on their ability to second-guess the direction of g-sec yields or corporate bond spreads, rather than MPC actions.
Sweet spot for savers
While the MPC’s rate actions are increasingly leaving borrowers cold, savers aren’t much affected by them either. One-year term deposit rates for banks, which used to hover at 8 to 8.75 per cent in January 2015 fell to 6.25-6.75 per cent by August 2017, taking cues from the MPC’s rate cuts. But in the past year, with their deposit flows flagging and credit offtake picking up, banks have been loath to sharply slash their deposit rates.
Here, there has been a fair bit of divergence between the actions of CASA-rich banks such as SBI and HDFC Bank, who have effected sharper cuts in their term deposit rates, and their smaller peers who have had to offer high rates to woo depositors. Today, while the one-year deposit rates for SBI and HDFC Bank hover at 6.8-7 per cent, many private and small finance banks offer 8.5-9 per cent.
The liquidity crunch for NBFCs has made sure that deposits with AAA-rated NBFCs enjoy high rates of 8.5-9 per cent too, bearing no correlation to either the repo rate or deposit rates of leading banks.
The Government has done its bit to delink interest rates for small savers from the policy rates too, by holding on to rather high rates on its post office schemes. Though their interest rates are supposed to be pegged to the prevailing g-sec yields, interest rates on the PPF, NSC and five-year post office deposits are now at 7.7-8.7 per cent. While there is much cribbing about this, given the lack of social security net in India, higher rates for specific categories of small savers aren’t unjustified.
This growing disconnect between the MPC actions and lending rates has led to a clamour for the RBI to crack the whip on banks to somehow ensure transmission of policy rates. But the RBI has already made one too many interventions on banks’ pricing of loans, none of which have worked. Banks should now ideally be left free to price their deposit and loan rates based on their commercial interests, risk assessments and demand-supply factors, rather than go by an artificial external rate.
Market forces exerting a greater influence on interest rates, which are breaking free of policy actions, is a sign of a maturing Indian debt market. It is therefore futile for the Centre or the industry to expect the RBI or MPC to single-handedly repair broken consumer or business sentiment. A repo rate cut is no longer a magic pill to cure all economic woes and it is time we came up with alternative ideas.