RBI keeps repo rate intact, dashes hopes

Despite an acute cash crunch, the Reserve Bank of India (RBI) has preferred to keep the rate at which it lends money to banks (called repo rate in banking parlance) unchanged at 6.25 per cent, dimming hopes of retail customers and industries.

However, demonetization scheme has put back about Rs 11.5 lakh crore back into the banking system, according to the latest figures disseminated by the RBI. This is going to encourage banks to cut deposit rates and lending rates as the system is awash with liquidity.

The customers were riding high on expectations of an immediate drop in interest rates by around 25-50 basis points (one basis point is equivalent to one-hundredth of a percentage).

The central bank has however lifted the new measure—100 per cent hike in the cash reserve ratio (CRR) it brought in post demonetization, which will release Rs 3.25 lakh crore back into the economy, to make the banking system flush with funds. This will of course be checked in part by the Rs 60,000 crore of market stablisation scheme (MSS) bonds. Such bonds are issued by the government to mop up excess liquidity in the system.

As many feared, the central bank has also lowered the GDP growth forecast by 0.5 per cent to 7.1 per cent for 2016-17 saying there is a growth slowdown in the cash-intensive sectors.

RBI Governor Urjit Patel said, "Repo rate is unchanged to keep the objective of achieving consumer price index (CPI) inflation at five per cent by the fourth quarter of 2016-17 and the medium-term target of four per cent within a band of two per cent variation on either side. Upturn in select categories of food items and also the pick-up in oil prices need to be assessed. We would also like to see the impact of the 7th pay commission on inflation. We will depend on more data before cutting rates."

Bankers had mixed reactions. While Arundhati Bhattacharya, chairman of State Bank of India (SBI), said she is surprised, Chanda Kochhar, MD & CEO of ICICI Bank, said that lending and deposit rates would become softer.

Others like Rana Kapoor, MD & CEO of YES Bank, said they expected sharper cuts post the US Federal Reserve meeting next week. But with the unending stream of funds, banks will be left with little choice but to soften rates.

Bhattacharya said, "The decision of keeping the repo rate unchanged was a little surprising given that there has been sizable demand destruction. Probably, this may have happened due to considerations of possibilities of rise in energy prices as well as with an eye on Fed rate hike. But the combination of removal of incremental CRR limit and MSS Scheme will help banks to manage their liquidity conditions better and bring financial stability to the system."

Kochhar said in a release that the policy has taken an accommodative stance. She said, "With regard to liquidity and interest rates, the withdrawal of the incremental Cash Reserve Ratio requirement and the use of other instruments such as the Market Stabilisation Scheme to manage liquidity is welcome. Deposit and lending rates are expected to continue to show a downward trend going forward."

Excessive liquidity in the banking system and the lack of demand for credit is going to keep the banking lending and deposit rates down for a while. As the cost of deposits fall banks will be forced to reduce their lending rate.

Rajeev Rishi, chairman of Indian Banks Association (IBA), said, "Withdrawal of incremental CRR would also provide enough comfort to the banks as they will save on cost which could encourage them to take a call on lending rates. As for banks, lower GDP projection also indicates further deceleration in credit off take."

Some bankers are hopeful that repo rate reduction should come in post the Federal Reserve meeting.

Rana Kapoor said, "The policy is a reflection of RBI's confidence and conviction that the impact of demonetization on growth is transitory, and the mid- long-term benefits are positive for the economy. Further, the rollback of incremental CRR hike augurs well for the banking sector as a whole. Post the outcome of the US Fed meeting, and stabilisation of the demonetization initiative, in my opinion, there will be room to deliver a 50-75 bps cut in the repo rate, in the next post-Budget meeting in February, and surely by April 2017."