Raghuram Rajan rate cut: Too little, too soon

Raghuram Rajan is a man of few surprises. Yet, two weeks back, the Governor of the Reserve Bank Of India (RBI) did announce a 25 basis point cut in repo rates, much ahead of a quarterly policy review. The markets gave a standing ovation. Banks however, are very much sitting in their cushy chairs, avoiding glares and a very obvious question, “Are you going to follow suit and cut lending rates as well?”

Everyone is waiting for an answer, mostly in the affirmative. The multitude who want an ease in the interest rates include retail customers with loans, corporates who have been making huge entries in the interest cost section of balance sheets, and equity investors who are hoping the banking system too will go along with the positive environment that election of Narendra Modi has created.

Banks however have a long way to go, before they make everyone ‘feel good’. They are sitting on non-performing assets (NPAs) and restructuring assets worth Rs 6,00,000 crore. Due to the provisions that they have been taking because of NPAs, their net interest margins (NIMs) have been taking a hit in their quarterly results. If they reduce base lending rates, NIMs will truncate further, making them ‘look bad’, if they choose economic altruism over their own interests. This is also the last quarter of the financial year, and their last chance to clean up their balance sheets.

Rajan however, had been indicating or rather, directly asking the banks to cut interest rates to boost the economy. He, along with many others, see it as perfect timing. The consumer price inflation has come lower than expected at five per cent, easily one of RBI’s major worry and the reason for its former stance of tight rates. Corporates are already showing signs of revival in investing proved by increased private equity activity, thanks to trust in reforms everyone expects Modi government to bring in. Globally too, crude oil prices have been falling, along with other commodities, giving way to an ease on the input prices side for many industries in India. The last cog to get the wheel of economy rolling is banks going easy on their rates.

A lot more however has to happen before undoing the policy disappointment of the last five years. Banks are waiting for ‘real’ reforms from the Budget in the end of this month. Many companies too are expecting Modi to create an investment-friendly environment across India, like he did in Gujarat. It is yet to be done and is not a long wait for banks, before they jump the growth gun.

Banks have been dealing with a strict RBI for the last few years. It has just about started easing its rate stance. Banks too must be waiting for larger rate cuts to happen over a period of time, and more often. This seems plausible according to many analysts, as consumer price inflation to ease further and wholesale inflation is expected to slip to negative territory. Analysts see a cumulative 150 basis points cut over the course of 2015 in steadier fashion, if external volatility does not impact much.

Banks however are all not against a lending rate cut. Some banks have been cutting deposit rates indicating a possible reduction in borrowing rates as well. They have been holding Asset-Liability Committee (ALCO) meetings, without any decisions, showing that they too are in the wait-and-watch mode. Banks have qualms from the demand side as well. Credit growth is not picking up due to the dual-effect of slow investment as well as high interest rates. They have to fix this too, along with giving ease to corporates who are in the midst of restructuring assets, if interest rates decline. That could be one elephant in the room they could address before banks chase growth.  

Tuesday’s quarterly review is one of the events that banks are watching for. Will Rajan be extra generous to push banks for more rate cuts? Or, will he wonder why banks are not following his direction and already going in for rate cuts? Will that make him stand back and wait? We are waiting to watch. 

Katya B Naidu has been working as a business journalist for the last nine years, and has covered beats across banking, pharma, healthcare, telecom, technology, power, infrastructure, shipping and commodities.