RBI Cuts Rate More than Consensus – Will Banks Pass on to Consumers ?

Given the unique growth-inflation dynamics of Indian Economy, the RBI was expected to ease rates for the first time in three years. However, it surprised positively – cutting its key policy rates by 50bps – higher than expectations of a 25bps cut. The repo and reverse repo rates now stand at 8% and 7% respectively. The cash reserve ratio (CRR) was left unchanged at 4.75%.

What is Beneficial to the Banks ? The RBI raised the borrowing limit under the marginal standing facility. This allows banks to borrow overnight to the tune of 2% of NDTL v/s 1% earlier at a rate that is 100bps above the repo rate.

Why Banks May Not Pass on the Rate Hike ? We do not think that we are not in a rate cut “cycle”. From banks perspective, the key variable is LD [Loan to Deposit] ratio – which stands at almost all-time high levels of 77% and deposit growth has been anemic at less than 15%. Given the requirement of banks to invest in government bonds and maintain reserves with RBI, LD ratio above 75% implies that high rates are here to stay, is our take.

We all know that Lower rates help loan growth and slow down deposit growth. RBI is forecasting deposit growth of 16% in F13 and loan growth of 17% – implying it expects LD ratio at 78% by end F13. This will prevent banks from cutting rates aggressively.

In the forward guidance, the statement emphasized the limited space for further rate cuts due to the “modest” slack in the economy and persistent upside risks to inflation. Furthermore, inadequate steps to contain fiscal subsidies “will further reduce whatever space there is” for policy easing. The 50bp policy rate cut revealed a lot of pent up desire to cut rates, but it may have been a bit premature and too aggressive considering the stickiness of inflation, rising inflation risks, and large twin deficits.