Does RBI policy need the attention it is getting?

On Friday, the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) raised the repo rate by 50 basis points to 5.4%. The repo rate is the interest rate at which the RBI lends to commercial banks. One basis point equals 0.01%. With this, the repo rate is now higher than in February 2020, the early stages of the covid pandemic.

When the RBI raises interest rates, the hope is that this will result in higher lending rates from banks, which will make borrowing expensive and in doing so dampen demand. With lower demand, less money will chase the same set of goods and services, resulting in a lower rate of price increase or lower inflation.

Show full picture

Theory vs practice

So, is it happening? As of July 15, annual non-food credit growth was 14.6%, which isn’t exactly slow. This is the strongest annual growth in non-food credit since December 2018, when it was 15.1%. Banks lend to Food Corp. of India and other state procurement agencies to purchase mainly rice and wheat directly from farmers. What remains is non-food credit.

Interestingly, non-food credit growth only picked up when the RBI raised the repo rate in recent months. It could very well be argued here that the low base effect is at work. This time last year, the economy was suffering the aftermath of the second wave of the pandemic. But even if we look at two- and three-year non-food credit growth rates, they are growing faster than in the past.

This could be explained by the fact that the banks did not pass on the increase in the repo rate to their borrowers. But this is not true.

In June, weighted average commercial bank lending rates on new rupee loans stood at 7.94%, 43 basis points higher than in April. Additionally, news reports and anecdotal evidence tell us that lending rates have increased since then.

The second reason could be that monetary policy takes time to become effective on the ground. That said, the RBI should have started raising interest rates some time ago instead of waiting as long as it has.

Interestingly, in a May column on the pages of Mint Views, economist Madan Sabnavis looked at past data and concluded that “high repo rates haven’t really slowed the growth of credit granted by the system. banking“.

Ultimately, potential borrowers are more likely to borrow if they believe they will be able to repay their loans. It depends on their confidence in their economic future and has a very weak link to the repo rate, especially if a central bank is behind the curve.

On the other hand, as always, the banks are making the most of this situation. They quickly raised their lending rates but are slow to raise deposit rates.

In April, the lowest and highest term rates for deposits over one year ranged between 5% and 5.6%. By the end of July, they had risen slightly to 5.3-5.75%.

If we look at the weighted average rates of commercial banks’ domestic term deposits, they barely rose from 5.03% in April to 5.13% in June, an increase of 10 basis points. As mentioned earlier, lending rates on new domestic loans over the same period had increased by 43 basis points. Obviously, banks raise lending rates as soon as the RBI starts raising the repo rate, but for deposit rates, they wait for market momentum to catch up.

As the data cited in this article shows, we may be devoting far more time and attention to analyzing the RBI’s monetary policy actions than they deserve.

Catch all the trade news, market news, breaking news and latest updates on Live Mint. Download the Mint News app to get daily market updates.

More less

To subscribe to Mint Bulletins

* Enter a valid email

* Thank you for subscribing to our newsletter.

About Virginia Ahn

Check Also

UniCredit (OTCMKTS:UNCRY) PT raised to €17.00 at Berenberg Bank

UniCredit (OTCMKTS:UNCRY – Get Rating) had its price target raised by Berenberg Bank equity research …