RBI holds repo rate; what’s in store for borrowers and depositors?

With the CPI inflation moving up in recent months, the RBI has kept policy repo rate unchanged at 4 per cent. The move has been on expected lines, as high inflation in the near term leading to negative real rates had limited the RBI’s scope for further rate cuts.

For now, it appears that the RBI may wait for the CPI inflation to move lower on a sustainable basis to its comfort zone of 4 per cent, before embarking on future rate cuts. With the RBI expecting inflation to move lower only in the second half of the fiscal, there could be a long pause before further rate cuts.

So what does this mean for borrowers and depositors?

The sharp cut in repo rate (115 bps) so far this year has led to a fall in lending rates on new loans linked to repo. With the RBI going in for a long pause, further fall in lending rates may be limited. As such, the pass-through benefit for the larger section of borrowers has been weak. Unless banks lower MCLR by a faster pace (the earlier benchmark) or more borrowers move under the repo-linked regime, the full benefit of rate cuts up until now may not be visible.

Hence, for borrowers stuck with older loans under MCLR, moving to repo-linked loans may help lower EMIs in the months ahead, as RBI keeps its repo rate unchanged.

For depositors, however, the pain may continue for some time given the persisting excess liquidity in the banking system. Banks may continue to cut deposit rates, much to depositors’ chagrin, though the pace of cuts may moderate going ahead.

Old vs new loans

After the 135 bps reduction in repo rate in 2019, the RBI slashed policy repo rate by 75 bps in March to 4.4 per cent. In May again, the RBI cut the repo rate further to 4 per cent. While the sharp repo rate cuts have led to a fall in lending rates, it has varied widely between banks and types of loans (MCLR vs repo-linked).

For instance, while the RBI’s repo rate has fallen by 115 bps so far this year, the weighted average lending rate (on outstanding loans) has fallen by just 40 bps. However, the weighted average lending rate on fresh loans has fallen by about 1 percentage point.

Why this wide difference?

Banks introduced repo-linked loans from last October (on RBI’s directive). Under this, banks are forced to re-price their loans almost immediately after a rate action by the RBI. This has led to a sharp fall in lending rates on new loans benchmarked against the repo rate and hence transmission here has been much stronger.

But what really matters is the benefit of RBI’s rate cut being passed on to the larger section of borrowers, which, based on the average lending rate on outstanding loans, appears far from satisfactory. A key reason behind this weak transmission is the still poor pass-through of rate cuts to the earlier MCLR benchmark.

Sample this. Between January and July, the one-year MCLR has fallen by about 70 bps on an average across banks. In fact, while PSU banks have seen a 75 bps fall in MCLR, in case of private banks, the decline has been just 30 bps.

With 50-60 per cent of the overall loans in the banking system still under MCLR, the weak transmission of RBI’s rate cut on MCLR has failed to benefit the larger group of borrowers. Lack of awareness and reluctance on the part of banks to shift borrowers to the repo-linked regime has compounded the issue.

Hence, from the borrowers’ perspective, it would make sense to shift to cheaper loans now, to lower EMIs in the coming months. In many banks, the difference between one-year MCLR and repo-linked benchmark is a wide 30-50 bps. Borrowers can save substantially on their monthly outgo by moving to repo-linked loans straight away (after considering other factors such as remaining tenure of loan, cost savings etc.). Of course, borrowers will have to be ready to face higher volatility in rate movements (even when rates increase).

More pain for savers

With the RBI cutting its policy repo rate sharply over the past few months, savers have been particularly hit hard. Since March this year, bank fixed deposit rates have fallen by 100-150 basis points across many banks, even higher in some cases. As a result, savers are stuck with bank deposit rates that are at near two-decade low levels.

As of end July, PSU banks on an average offered about 5-5.4 per cent on their 3-5 year deposits. However, a few private sector banks still offer much higher rates (over 7 per cent in some cases).

While the RBI keeping the repo rate unchanged will lessen the pain for depositors, further cuts in deposit rates cannot be ruled out. This is because banks’ sitting on excess liquidity and weak credit growth will continue to trim deposit rates to safeguard their margins.

Over the past few months, substantial liquidity infusion via open market operations (OMO) and term repos, various policy actions by the RBI taken to ease liquidity conditions for NBFCs/HFCs, long term repo operations, reduction in repo and reverse repo rate have all led to a steep fall in short term interest rates. In fact, most of the rates are below the prevailing repo rate of 4 per cent; in some cases close to or below the reverse repo rate, too (3.35 per cent).

Banks have been parking surplus funds with the RBI under the reverse repo (even at meagre rate of 3.35 per cent). To cushion the impact of lower returns, banks will continue to cut deposit rates, until credit demand picks up substantially.

Hence depositors may see some more pain ahead in the coming months.