Should Raghuram Rajan cut repo rate again tomorrow?

The industry wants, the banking sector wants it and the finance minister wants it. Reserve Bank of India (RBI) has already heeded to their pressure, twice. There have been two rate cuts in India already in this new year but banks, barring a handful, refuse to lower their lending rates. 

So, why lending rates aren't following RBI's footsteps? This leads us to the question whether RBI is administering the wrong pill for the ailment. 

Even after two rate cuts that has brought repo rate (the rate at which RBI lends money to banks) down to 7.5% from 8% lending rates continue to remain high and a cause of concern for India Inc and the government alike. 

But what this also tells us is that cutting down repo rates is not really an efficient way for RBI to bring down interest rates. 

Madan Sabnavis, chief economist, Care Ratings, in an emailed response, said, "When RBI lowers repo rate, the base rate gets affected to begin with as it  is a part of the calculation. The cost of finance through repo is very small and hence the base rate does not change significantly." 

This is a sentiment echoed by a top ex-banker as well. The ex-banker, said, "Banks get their funds from variety of sources and borrowing from RBI is generally a very small part of it. Therefore, lowering of repo rate doesn't affect the total deposit rate of banks and that is why you are not seeing banks lowering lending rates." 

The banker went ahead to say that RBI must look at other avenues available with them to translate its action into tangible results. 

To be fair, banks have been saying the same. 

They argue that deposit rates need to come down first which will result in lowering of general cost of funds and that will bring interest rates down for lending. 

Sabnavis said, "When the repo rate was 8% the deposit rate averaged 8-9.25%, and with the repo rate at 7.5%, it averages 8-8.75%. hence, while banks have lowered the rate, it may not be proportional due to fear of losing deposits. This year, growth in deposits has been lower at 11% so far compared with 13.5% last year." 

Moreover, this presents another issue. If banks cut deposit rates quickly then it may result in capital flight as depositors might abandon banks in search of other avenues that provide higher return like PPF and debt funds. 

Therefore, the fall in deposit rates is a slow process and its affect might not been seen for at least 9 to 12 months. 

In that case, what options does RBI have to bring down lending rates and kickstart investment in India? 

Sabnavis said ,"RBI can do little except lower repo rate or cut CRR. When CRR is cut liquidity increases and should lower rates. however, if banks choose to reinvest in GSecs, then the liquidity situation returns to normal. As RBI cannot force banks to lower interest rates, it is really left to them to take their time. that is what RBI maintains that the impact of rate cut is seen after 2-3 quarters. Hence we cannot expect immediate cuts from banks. Besides as we are in march banks will not lower rates and offer higher rates to balance their books due to year end." 

RBI even tried with cutting Statutory Liquidity Ratio (SLR) by 50 basis points in first week of February to provide more liquidity with the banks. That too, has failed to move the cogs of the banking wheel. 

Although banks cite poor liquidity (among other issues) as a reason to hold on to high lending rates, an SLR cut in February provided an additional Rs 45,000 crore but yet failed to impact lending rates in any way. 

Does this leave the RBI with any option? Sabnavis thinks no. He said, "I do not think they (RBI) have other options. SLR cuts do not matter as banks are holding on to excess SLR already and this does not make much difference."