The failure of monetary easing to translate into lower borrowing costs is prompting much frustration — and acres of newsprint — in India. Don’t expect that to change today.
So far this year the Reserve Bank has cut the policy repo rate twice, and is expected to do so for a third time on Tuesday, taking the rate to 7.25 per cent. But banks in India’s fragmented financial sector have resisted passing these changes onto consumers.
Some analysts have argued that stressed balance sheets are the culprit. It is certainly true that many of India’s companies have saddled themselves with debt to fund expansion and left rising levels of non-performing assets on banks’ loan books. Another headwind, linked to the first, is the need to bolster capital in the face of more stringent international standards.
But flying under the radar is a structural reason not many beyond Asia’s third biggest economy are acquainted with. Individual Indian banks set what is confusing called their own ‘base rate,’ which is essentially the average of the total cost of their loans and deposits, rather than a reflection of wholesale borrowing costs as it is in in many major markets.
Five years ago the system was overhauled replacing a previous, more variable industry-lending rate akin to Libor with a system that allowed banks to price loans more as they saw fit and set a base rate, or floor, at which they would not price loans below.
But this has resulted in a more rigid system that does not allow for the natural transmission of central bank rates to the real economy, even if banks still hold reservations about stressing their balance sheets even more. We’ll let the RBI and the banks thrash it out as to how much wiggle room they actually have, but the base rate mechanism isn’t helping.
And here’s the final rub: even if banks do take the plunge and begin lowering interest rates, it may not have much of an impact on the people most in need of a loan: consumers and small- and medium- sized enterprises (the last thing most large Indian corporates is more debt). Crudely speaking, India is not a nation of borrowers: only a fifth of outstanding loans are for things like mortgages and credit cards, compared with around 55 per cent in the UK.
Moreover interest rates have been sticky in the last 3.5 years: since the start of 2012 they have moved in a range of between 7.25 per cent and 8.5 per cent. Which makes one question what psychological impact a cut in the quantum of 25bps will have on borrowers’ sentiment.
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