Why consumers will barely benefit from the RBI move?

Updated: Apr 20, 2012, 11:19 AM IST

The party for Indian consumers has fizzled out even before it started.

The Reserve Bank of India's surprise half-a-percentage-point cut in a benchmark interest rate, the first reduction in three years, revived hopes that interest payments on monthly loans would reduce by an equivalent amount.

However, banks seem reluctant to pass along the entire scope of the cut to consumers, even though the industry also has benefitted from a 1.25-percentage-point reduction in the reserve levels banks are required to keep on hand at the RBI.

ICICI Bank, Punjab National Bank and IDBI Bank were among the initial few that announced a reduction in their base lending rate -- but only by a quarter of a percentage point.

So why is there a reluctance to cut rates aggressively when even government officials feel public-sector bank are charging more than their privately-run counterparts on retail loans, especially home loans. Indeed, the financial services secretary, D.K. Mittal, recently wrote to state-run banks to "review" their interest-rate structure.

The general argument for a slow easing of lending rates is that deposit rates have to come down first, the cost of funds has to reduce and then lending rates will follow.

But deposit rates are unlikely to fall anytime soon. Here's why: Of every 100 rupees a bank raises in deposits, Rs 24 has to be mandatorily invested in government bonds. Another Rs 4.75 has to be set aside as reserves with the Reserve Bank of India.

The bank is then left with Rs 71.25 to lend in the market. However, the loan-to-deposit ratio of the banking system today stands at nearly 77 percent, which means banks are already lending more than they can raise through available deposits by borrowing from the central bank. Simple economics -- more demand, less supply -- suggest that interest rates are bound to remain high because deposits are scarce.

If that was not enough, the government plans to borrow a record amount of Rs 4.79 trillion in the year that began April 1. The large borrowing is expected to rake up funds from banks, leaving them with less to lend -- so interest rates are likely to stay high.

Third, with fewer funds in the market, banks are forced to pay a higher interest rate to attract the crucial bulk deposits of companies. And, if deposit rates remain high, so will lending rates.

But why do banks have fewer funds on hand? The villain, ladies and gentlemen, is the same monster that the Reserve Bank of India has been trying to tame for the last three years by raising interest rates 13 times: Inflation.

"Inflation is high but income levels haven't risen, so people have to spend more and that's why savings are less," says Madan Sabnavis, chief economist with rating agency Care.

Even the mutual funds and the choppy local stock markets are witnessing a sharp decline in retail participation as returns are poor. Gold, the metal for all seasons and a hedge against inflation, has also lost its sheen after the government raised the import duty on it.

The bottom line is that raising deposits will continue to be a challenge for banks until the genie of inflation is put back in the bottle. And lending rates may come down a bit, but not to the extent that any consumer will be celebrating.

Dow Jones

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