Why rate reductions haven’t lifted credit growth

Madan Sabnavis | Updated on August 09, 2019 Published on August 09, 2019

Interest rate matters less

Weak transmission of rate cuts apart, the slowdown in the manufacturing and infra sectors is curbing the demand for loans

The RBI cutting the repo rate by 35 basis points (bps) did catch one’s attention, but didn’t stir up much excitement. The novelty is only in the quantum of cut — 35 bps — as it is the first time that such a change has been invoked. However, scepticism still persists on whether the rate cuts translate into lower lending rates and finally to higher bank credit.

A look at some facts first. Since February there has now been a 110 bps reduction in the repo rate, of which, 75 bps came between February 7 and June 6. How have interest rates reacted? First, the weighted average interest rate on deposits came down from 6.91 per cent in January to 6.84 per cent in June. The weighted average lending rate (WALR) for fresh loans of all banks came down from 9.97 per cent in January to 9.68 per cent in June which is lower by 29 bps and hence a better response.

The median value of MCLR (marginal cost of funds based lending rate) for one year for all banks came down from 8.80 per cent to 8.60 per cent during this period, which also shows that the WALR on fresh loans are not really priced very differently from the MCLR — 117 bps in January and 108 bps in June.

The third bit of information which is interesting is the change in bank credit during the period February 1, 2019, and July 19, which is the latest date for which information is available. The increase was ₹2,274 billion which is lower than last year’s ₹3,763 billion. This calls for an explanation.

The way the MCLR reacts is predictable. It is based on a formula which involves, among others, the cost of deposits, which is the main component, and the repo cost. Also, the MCLR becomes applicable immediately when the rates are revised while bank deposits get priced only when they are renewed or fresh accounts opened.

This is one reason why lending rates will be stickier as banks would have a disadvantage of costs not coming down while interest earned decreases. The repo cost per se will not matter as it is applicable to not more than 1 per cent of NDTL (net demand and time liabilities) which is permissible under LAF (liquidity adjustment facility). Besides, with surplus funds in the system the LAF cost will be negative as the reverse repo and term reverse repo windows are the bigger ones.

The other issue is even more fundamental and pertains to the increase in credit. It is assumed that when lending rates are lowered, borrowings will increase.

In the present scenario the WALR on fresh loans has come down by almost 30 bps between January and June 2019. Yet incremental credit has been lower than that of last year. The explanation is on the demand side.

Demand side issues

Corporate India presents an ambivalent picture. Capacity utilisation rates are still low with several industries in the consumer domain like automobiles and consumer durable goods witnessing drop in production, fresh investment is ruled out. Infra projects require funding but have been limited in the private sector as problems persist in telecom, power, road and such other projects.

It has been iced by the high NPAs (non-performing assets) on the books of banks.

Individuals’ demand for loans would be driven by new people joining the spending stream that is caused by job creation and rising incomes of existing employees. Quite clearly, this is not happening at a great pace which puts barriers also on demand for loans.

Hence if one looks at the approach of the MPC (Monetary Policy Committee) to policy rates , the direction is clear — the focus has shifted from inflation to growth. There will be more rate cuts for sure as long as inflation remains benign and growth stagnant. The efficacy of these measures is still unknown.

Interest rates as a rule have tended to move downwards over the years; yet the gross fixed capital formation rate has declined and is quite stagnant now, at 28-29 per cent of GDP, from 34-35 per cent levels earlier. Banks have a preference for GSecs as the 6-6.5 per cent help them meet the LCR (liquidity coverage ratio) targets.

It may hence be the same story being repeated where lower rates lead to some increase in credit, though not to the extent that it enthuses lending significantly in a rather stagnant economy.

The writer is Chief Economist, CARE Ratings. Views are personal

Published on August 09, 2019
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