India's Banks Not Sharing Policy Benefits, Delivering Additional Blow To Consumer Spending 1

No rate cut bad for consumers?

At a time when demonetization has tightened Indian consumers’ (INCO) purse strings, there was expectation that the RBI (Reserve Bank of India) would help the consumer by reducing its repo rate. This, in turn, will signal banks (HDB) (IBN) to reduce their lending rates, which will help credit off-take and reduce the loan burden on consumers by reducing interest rates on loans.

However, with no rate cut taking place, there is a worry that the loan burden of consumer will not come down, dealing another blow to consumer spending and, in turn, economic activity.

But worries regarding declining loan rates should not be that grave.

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Monetary transmission to still take place

Monetary policy transmission refers to the translation of monetary policy actions into the financial system via banks. By changing the short-term interest rate, a central bank signals commercial banks to change their lending and deposit rates. It can’t force them to make the change, though. Hence, the efficiency of monetary policy transmission rests with commercial banks.

The RBI has been on a rate cutting cycle since January 2015. From that time until February 2017, six rate cuts have been effected, worth a combined 175 basis points. However, banks have not passed on the entire benefit to consumers. Realistically, they are not able to as they need to maintain a spread for themselves. But they still have some room, even in the face of no rate cut in February, to reduce interest rates.

Hence, a decline in the monthly reviewed marginal cost of funds based lending rate (or MCLR) can be expected, which should translate into lower interest rates on loans. Another reason why MCLRs can see a decline is because banks are flush with funds, and even with no rate cut, can reduce lending rates in order to increase credit off-take.

This will help improve monetary policy transmission and give consumers reason to start spending on big-ticket items like autos (TTM) and homes again.

In the next article, let’s look at what’s in store for India going forward – both in terms of the economy and monetary policy.

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