RBI takes the lead, banks must now respond
In a rare case, it's not just the quantum of the interest rate cut the Reserve Bank of India announced on Tuesday that is important. The reduction is significant for two other reasons, because in them lies a message. The drop is the first since Urjit Patel took over as RBI Governor; and, it's the first decision the newly constituted Monetary Policy Committee (MPC) has taken. The message is that the RBI and the MPC are open to easing interest rates to boost growth while simultaneously keeping an eye on inflation. The latter concern is what made the MPC to effect a moderate reduction in the rate of interest at which the RBI lends money to banks.
But it does appear that Patel is not as phobic as his predecessor was on inflation; he pointed out that the four per cent targeted inflation (plus or minus two per cent) was spread over five years and not to be necessarily reached in early 2018. Now that both Patel and the monetary panel have debuted with an announcement which will be welcomed by the Government, the industry and credit rating agencies, it is for the banks to ensure that they pass on the benefits to the consumers, who too are stakeholders in the process. Because, if this does not happen, it will fail to have an impact on sectors like consumer durables and real estate that are looking for a major kick-start in growth. For the common man, the rate cut means nothing if it does not ease his interest burden on loans taken. Banks have in the past been criticised for not fully passing on the benefits of reduction to consumers.
For instance, while the RBI has slashed rates by 1.75 percentage points since January 2015, home loan interest rates have come down by less than one per cent. To add to the discomfiture, banks have lowered deposit rates by 1.35 percentage points in the same period. Consumers, therefore, have a valid reason to keep their fingers crossed. Of course, banks have had some justification in being conservative. Their books are stressed as they have been struggling with bad debts. The RBI Governor acknowledged the limitations within which banks are functioning, when he said the RBI would be both pragmatic and firm. However, not responding to the RBI's initiative in a substantial manner can negatively impact the banks' business too. Few experts had expected a rate cut this early; most estimates predicted it only by December. Now that it has happened, the onus is on the banks to do their bit.
The quibbling over the quantum and the timing apart, it cannot be denied that the MPC's decision comes on the heels of a manageable inflation rate, a bountiful monsoon, a comfortable foreign exchange reserve, a large flow of foreign direct investment (FDI) and a well-controlled current account deficit. Besides, the Government has managed to fast-track a number of projects stuck for years on various grounds, primarily in the infrastructure sector, and is looking for large investments in new ones such as Make in India and Digital India. Months ago, it had dramatically eased FDI norms in over a dozen areas. India has gone up in the ‘ease of doing business' ranking. All of this is good news, but the key lies in taking advantage of the positive environment. The RBI interest rate plays a crucial role in this endeavour.