Finance

Andy Mukherjee is a Bloomberg Gadfly columnist covering industrial companies and financial services. He previously was a columnist for Reuters Breakingviews. He has also worked for the Straits Times, ET NOW and Bloomberg News.

India just ushered in an interest-rate cut, via the backdoor.

Although paying postal-savings depositors slightly less for their cash may appear a minor tweak, the move could end up having a bigger salutary effect on bank balance sheets, and the country's nervous bond market, than the Reserve Bank of India's 125 basis-point reduction since early 2015.

In an unexpected decision Friday, the government trimmed the one-year time deposit rate on postal savings to 7.1 percent from 8.4 percent. By comparison, State Bank of India, the country's largest lender, pays 7.25 percent annually for one- to three-year funds.

Why Bank Deposits Lost Their Sheen
Small savings plans in India were limiting lenders' ability to attract low-cost funds
Source: Bloomberg, India Post

The nation's tax-free public provident fund, which is used by the self-employed as well as the salaried, will now offer 8.1 percent, down from 8.7 percent.  

In aggregate, India's so-called National Small Savings Fund has $144 billion in the pool. To keep the fund from becoming unsustainable, both the federal and state governments are forced to borrow from it at more expensive rates than the bond market charges them. The middle class is naturally upset that authorities are no longer keen to expand this kitty by handing out overly generous risk-free returns, but investors in the country's bad loan-addled banks should be chuffed.

With government-sponsored small savings plans being told to curb payouts, it's quite likely that at least some of their customers will gravitate toward the banking system. And given just how high some banks' interest cost-to-income ratio has become, particularly for the weaker state-run ones, lenders as a whole will jump at the opportunity to regain access to cheaper funds.

Cheaper Deposits Would Be Nice, Please
The interest cost-to-income ratio is more than 100% for several Indian state-run banks
Source: Bloomberg

Cutting deposit rates, along with slashing lending charges in tandem to push more money out the door, is one way for banks to boost flagging returns on equity amid high provisioning costs for soured debt. On paper, credit growth is at a 20-month high, but, as Bloomberg News reporters Anto Antony and Divya Patil point out, that's largely because companies have substituted their commercial-paper issuance with bank borrowing. A genuine recovery is still some way off.

Until then, banks can use the extra deposits coming their way to bulk up their bond portfolios. That would work to calm investors who have been worried about the market's ability to absorb a surge in issuance as state governments swap high-cost bank loans on their near-bankrupt power distribution companies' balance sheets with notes. Several states have already paid an average coupon of 8.49 percent to raise 10-year money this year, more than 2015's 8.15 percent.

An arguably bigger bonus, however, would be if Friday's move improves the transmission of the RBI's monetary easing. Not only would that help lower borrowing costs for highly leveraged infrastructure and metals companies such as Bhushan Steel and Jaiprakash Associates, it might also persuade central bank chief Raghuram Rajan to accept another term once his current tenure ends in September. A governor and the government working from the same playbook would go a long way in reducing investor anxiety.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Andy Mukherjee in Singapore at amukherjee@bloomberg.net

To contact the editor responsible for this story:
Katrina Nicholas at knicholas2@bloomberg.net