Rajan Supercharges India Rate Cut by Easing Bank Funding Squeeze

India's central bank cuts key rates

The Reserve Bank of India in Mumbai, India.

Photographer: Divyakant Solanki/EPA
  • Central bank lowers benchmark, takes measures to boost cash
  • Effects of Tuesday's rate reduction would be larger: Rajan

Reserve Bank of India Governor Raghuram Rajan is out to ensure the benefits of his five interest-rate cuts extend more widely into the world’s fastest-growing major economy.

While lowering benchmark borrowing costs by a quarter percentage point as expected on Tuesday, the central bank surprised the markets with a series of measures to ease a prolonged funding squeeze. FirstRand Ltd. says the steps will help bring down costs for lenders, encouraging them to pass on the RBI’s 150-basis point reduction in the benchmark repurchase rate over the past 15 months to households and companies.

Policy transmission has become the focus for Rajan, who has successfully tamed Asia’s fastest inflation and propelled foreign-exchange reserves to a record since taking charge in September 2013. With rebounding oil prices, a planned pay increase for government employees and uncertain monsoon rains limiting scope for lower rates, Rajan will want to make the cuts so far count.

“The transmission of rates will now probably happen in a much faster way even if we don’t see any more easing,” said Harihar Krishnamoorthy, the Mumbai-based treasurer at the local unit of South African lender FirstRand. “As banks start seeing liquidity in a more plentiful fashion, it will give them comfort to cut deposit rates, which will translate into lower lending rates.”

Indian sovereign bonds maturing in two years rallied on Tuesday, with the yield dropping five basis points to 6.99 percent, data compiled by Bloomberg show. It was at 7 percent on Wednesday. The yield on benchmark 10-year debt was steady at 7.46 percent, following Tuesday’s five-basis point increase on speculation the rate cut leaves Rajan little room for further easing.

Ten-year notes capped their best March performance since 1999 last week as bets that the RBI will ease helped extend a rally sparked by the government’s Feb. 29 budget decision to stick to fiscal goals. The rupee weakened 0.2 percent to 66.58 a dollar in a second day of declines.

Banks’ loan rates have failed to keep pace with the drop in the RBI’s benchmark despite months of goading by policy makers as lenders sought to shield margins amid a surge in bad debts. A seasonal cash crunch exacerbated by last quarter’s outflows of foreign money from Indian bonds boosted interbank costs, weighing further on lenders. The liquidity deficit in the banking system worsened to 2.3 trillion rupees ($34.6 billion) from 1.3 trillion rupees end-January, ICICI Bank Ltd. analysts wrote in an April 4 report.

‘Significant Change’

Transmission was the biggest bottleneck in India’s monetary policy, Rajan said in an interview with Bloomberg TV India in Mumbai on Wednesday, adding that yesterday’s rate cut will have a much bigger impact than in the past due to better transmission.

“I would see this as much more than a 25 basis-point rate cut,” Rajan said. Both industrialists and market players “will over time see that the effects of this would be larger.”

The RBI lowered the rate at which lenders access emergency funds under the central bank’s marginal standing facility, or MSF, by 75 basis points to 7 percent. It cut the daily balance requirement for banks’ cash reserve ratio to 90 percent from 95 percent, effective April 16. The central bank said it will buy bonds worth 150 billion rupees on April 7, adding to its open-market purchases that began in December. The RBI will continue to provide liquidity as required, with the aim of bringing the cash deficit at banks closer to neutral from the previous target of 1 percent of their own net demand and time liabilities.

“The policy is clearly geared towards fixing the liquidity conditions in the system through rates and product maintenance rather than exclusively focusing on policy rates,” Kotak Mahindra Bank Ltd. economists Madhavi Arora and Upasna Bhardwaj wrote in a report. “The effort towards moving liquidity closer to neutral is a big positive and a significant change in the RBI’s stance.”

‘Pleasant Gift’

Lenders including State Bank of India, the largest, have reduced their base rates by about 70 basis points or less since the start of 2015, much lower than the RBI’s 1.25 percentage-point cut in the repo rate in the period before Tuesday.

“The liquidity management measures were a pleasant gift to the market,” SBI Chairman Arundhati Bhattacharya wrote in a statement. They “will result in a predictable and stable liquidity regime going forward, facilitating better transmission across financial markets.”

Loans grew 11.3 percent in the year through March 11, according to fortnightly data from the RBI. That’s near the 11.6 percent increase seen in the period through Feb. 19, which was the biggest since July 2014. Credit growth sank to a 20-year low of 8.88 percent in February 2015.

The good news is credit growth is picking up, Rajan said in a conference call with analysts following Tuesday’s policy, adding that the RBI hopes to see significantly more rate transmission in the coming months.

‘Large Obstacle’

Rajan’s announcements Tuesday complement the government’s move last month to slash interest rates on small savings, which competed with bank deposits. The RBI also introduced marginal cost of funds-based lending rates this month to ensure benchmark policy-transmission and improve transparency in the way in which banks calculate charges on borrowings.

“The liquidity portion had been a very large obstacle to proper transmission of rates,” said Ananth Narayan, the Mumbai-based regional head of ASEAN & South Asia financial markets at Standard Chartered Plc. “The changes allow for liquidity policy to be an important adjunct to the monetary policy stance. I have no doubt that transmission will improve going forward and rates across the board -- whether bond rates, lending rates, deposit rates -- will come down. The shorter end of the curve should fall more.”

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