Friday , 20 April 2018

Rate cut is only a good beginning


Banks have started reducing lending rates; the cut is in the range of 65 to 90 basis points. The move is not surprising though the extent of the cut appears to be steep and sudden. It must be remembered that the Commercial banks have been quite reluctant in transmission of interest rate cuts announced by the RBI. The Apex bank has eased lending rates by 175 basis points in the last two years and the banks have promptly reduced the deposit rates but not the lending rates by the same margin.  For example, the largest lender SBI reduced the rates by 110 points during this period. Huge surge in deposits post-demonetisation was probably the biggest prompter; the PM’s address on the eve of the new year must have also played a major role in banks deciding to cut rates.

There was some fear that once the withdrawal restrictions are eased, most of these additional deposits will once again go away. Nothing of that sort seems to be happening in the banking sector. The Chairperson of SBI is predicting that more than 40% of incremental deposits would stay with banks. With spurting deposits, the cost of funds has come down to 3.5 to 4 %. Instead of just parking their funds in Government securities which will yield a return of no more than 6%, banks seem to have decided to lend rather aggressively. At the same time, banks will do well to do due diligence and keep prudential norms in mind while lending this time. Already the NPAs are quite high especially with public sector banks affecting their financial health, notwithstanding the fact that, at least a part of the NPA problem was due to RBI making the asset recognition norms more stringent late in the year 2015. Credit off-take has not picked up in the last three quarters and in December it dropped to a tepid 5.8% from 10.6% last year, according to RBI. Consequently, businesses, especially small and medium sized, have not been able to access funds at lower costs. This has had an unsavoury effect on investment and expansion.

Like always, the impact of rate cut would not be the same across all segments. In retail borrowings, new rates will apply only to fresh loans. Hence existing borrowers will either have to switch loans to other banks or will have to reset the loan after paying a certain fee. Usually, rate reduction would buoy the real estate sector. But this time around, the situation appears to be different with demonetisation stalling property transactions.

Similarly, rate reduction shall not benefit all the companies in the same way. Firms with better rating will be able to get cheaper loans while companies with high leverage will find it difficult. This rate cut comes on the back of another 90 to 100 basis points in the last couple of  years; so the impact on earnings of the businesses is bound to be positive. But whether the rate cut alone will induce firms to invest is a moot question. Post demonetisation, growth rate in the economy has taken a hit. The effect of this, though showing signs of tapering off, is yet to subside fully. The informal sector has been the worst hit and there are reports of widespread job losses. There are no signs of restoration of complete normalcy; even after that, there shall be a time lag before purchasing power and demand pick up effectively.

This is an unusually big rate reduction. Under normal circumstances, this should have been greeted with buoyant demand, increased earnings, higher stock market prices and added GDP growth rate. But in an economy that continues to face cash crunch, negative outlook for wealth creation and job losses, turn around will not be easy. Some sops have been announced by the PM especially for the poor in the informal sector. Budget holds the key in the next round. It is not just about giving doles, it is also about reforms such as GST and DTC for example, which will go a long way in bringing back the confidence and feel good factor amongst investors.

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