Bank account holders beware. Your deposit as well as lending rates are set to come down further. In a surprise move on Friday, the Reserve Bank of India (RBI) slashed its repo rate by 40 basis points (0.40 per cent), its second rate cut this year, in an effort to counter the economic impact of the lockdown imposed to curb the spread of the COVID-19 pandemic.
On March 27, the RBI had sharply lowered the repo rate by 75 basis points. The repo rate cut on Friday, the lowest since 2000, will lower the benchmark rate at which the central bank lends banks to 4 per cent from 4.40 per cent.
Consequently, the reverse repo rate will come down to 3.35 per cent from 3.75 per cent. In recent months, the central bank has taken several measures to ensure ample liquidity in the system, which will help in increasing bank credit. However, risk averse banks chose to park more money with the RBI instead. The RBI will be hoping that with this reduction in the reverse repo rate, banks will find it less attractive to just deposit the cash with the central bank and thus, will in turn look to lend more.
Over the last two monetary policy committee (MPC) meetings, the repo rate has now come down by 1.15 per cent. This comes in the backdrop of an already slowing down economy, now expected to contract in the financial year ending March 2021.
“It is in the growth outlook that the MPC judged the risks to be gravest. The combined impact of demand compression and supply depression will depress economic activity in the first half of the year,” said Shaktikanta Das Governor of RBI.
RBI’s assumption is that the economic activity will get restored only in a phased manner and the combination of fiscal, monetary and administrative measures being undertaken by the government and the central bank would create conditions for a gradual revival in activity in the second half of the financial year.
“Nonetheless, downside risks to this assessment are significant and contingent upon the containment of the pandemic and quick phasing out of the social distancing and lockdowns. Given all these uncertainties, GDP growth in 2020-21 is estimated to remain in the negative territory,” said Das.
The transmission in lending rate cuts has improved in the last few months. The one year median marginal cost of funds-based lending rate (MCLR) declined by 90 bps between February 2019-May 15, 2020, according to RBI data. The weighted average lending rate (WALR) on fresh rupee loans has cumulatively declined by 114 bps since February 2019, of which 43 bps decline occurred in March 2020 alone.
But, that also means that deposit rates could come down further too, hurting retail deposit holders. The interest rate cut will not be a good news for senior citizens and for those looking to park money in bank deposits to avoid the uncertainties in capital markets. Post the last MPC meeting, State Bank of India, the country’s largest lender, had reduced fixed deposit rates by up to 50 bps. Earlier this month, term deposit rates for some tenors were further reduced by 20 bps.
“We will convene our ALCO (asset-liability committee) meeting. It is a process where we review what is the impact of the announcements made by the RBI and accordingly, we decide on the deposit rates. But, obviously, the view as of now is that the interest rates are going down. When they go down, they go down for borrowers and they go down for depositors,” Rajnish Kumar, chairman of SBI told reporters.
Other bankers like Rajkiran Rai, MD and CEO of Union Bank of India, also feel deposit rates will further come down.
“A further cut of deposit rate will be a bit difficult because as it is we are at the lowest point. But, looking at the deposit growth, I think another 40-50 bps cut on the deposit side is possible,” he said on a TV channel.
With India’s economy expected to contract this year (ratings agency ICRA forecast 5 per cent GDP contraction), analysts say there will be more rate cuts ahead.
“With the indication that the growth will be negative, we continue to see space for some further rate cut though the efficacy of rate cuts will progressively be lower,” said Suvodeep Rakshit, senior economist at Kotak Institutional Equities.
Lakshmi Iyer, chief investment officer (debt) at Kotak Mahindra Asset Management Company, said a combination of regulatory and monetary measures are the much needed steroids for the ailing economy. “There is no doubt that Covid crisis and its repercussions on the economic prospects has led the RBI to announce these measures. The downward march of interest rates is likely to gain momentum with this move,” said Iyer.
The policy rate set by the MPC is not the sole factor determining banks’ MCLR, which also factors in the cost of deposits of banks. So, interest rates on MCLR-linked loans may yet take some time to see the full transmission of the repo rate reduction, pointed Naveen Kukreja, CEO of Paisabazaar.com.
However, in the last year, several banks have launched new loan products, which are linked to an external benchmark like the repo rate. In such loans, the transmission will be faster.
While the interest rate cut will have limited impact in the short term, it is helpful to revive growth over the longer term, said Rajat Rajgarhia, MD and CEO, Institutional Equities at Motilal Oswal Financial Services.