Bank Rate Cuts Are A Key Step In India’s Recovery

Indian authorities are finally getting what they wanted: lower borrowing rates from the banks. State Bank of India (SBI), the largest lender by assets, cut its lending rate by 90 basis points from Jan. 1. Other banks are following with similar cuts. That is a critical step to kick start credit growth but the uncertainties created by a nationwide cash crunch mean it is too soon to cheer an economic revival.

Prime Minister Narendra Modi admonished banks in his New Year’s Day speech, urging them to make sure the poor and middle class were a top priority. It was a veiled call to cut rates. The Reserve Bank of India has cut rates 175 bps in two years but lenders have not passed on the lower rates to customers.

The pressure for banks to act intensified after Modi’s big banknote recall led to the return of an estimated 14.9 trillion rupees ($218 billion), most of which is now deposited in customer accounts. The unprecedented liquidity in the system has lowered the cost of funds for banks, which have already in recent weeks cut their deposit rates.

Lower borrowing costs would ordinarily kick-start private investment – a pre-requisite for a broader economic recovery. India has reported high growth in GDP but underlying data is less encouraging. Credit growth has languished around 7 percent in the current financial year for SBI and manufacturing capacity utilisation was barely 72.9 percent in the quarter to June. Modi’s cash recall has since put a further break on demand.

That means any economic boost from lower lending rates will come later. It will also depend partly on the stickiness of new deposits. SBI Chairman Arundhati Bhattacharya reckons 40 percent of the new deposits will stay in the system but analysts are gloomier. Customers still have to queue at banks for cash, and withdrawal limits remain in place at ATMs. That suggests plenty of deposits could in time flow back out of the system. Bank rate cuts are just one step in the right direction.

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