Rate cut alone not sufficient, economists tell RBI
Mumbai, Jan 26, 2025
Bank CEOs to meet for pre-policy talk on Monday
Most economists who met Reserve Bank of India (RBI) top brass including Governor Sanjay Malhotra on Friday as a part of pre-policy consultations told the central banks officials that a rate cut may not be enough to reinvigorate the economy, which they said needed durable liquidity infusion.
Liquidity deficit in the banking system, measured by RBI pumping money through the liquidity adjustment facility, was Rs 3.3 trillion on Thursday, latest data shows. This deficit was the highest since January 24, 2024 when it touched Rs 3.43 trillion.
“Banks will not cut rates, the marginal cost of fund based lending rate as well as deposit rates unless there is sufficient liquidity in the system,” a source privy to the meeting said.
The external benchmark lending rate (EBLR), which is linked to the repo rate for most banks, would come down post a rate cut but MCLR -- the rate at banks lent to large and mid-sized corporates -- would not be impacted if liquidity deficit continues to stay high.
In fact, MCLR and deposit rates of banks inched up in December. The 1-year median marginal cost of funds-based lending rate (MCLR) increased by 5 bps in December. The weighted average domestic term deposit rates (WADTDRs) on fresh and outstanding deposits increased by 2 bps each in November, RBI data shows.
The six-member monetary policy committee (MPC) has kept the policy repo rate unchanged at 6.5 per cent since February 2023, which is almost two years now.
In the October policy review meeting, the stance, however, was changed to neutral. In December policy, two of three MPC external members voted to cut the repo rate. All the internal members voted for a status quo on both rate and stance.
The case for a rate cut has strengthened as headline inflation is expected to drop to 4.5 per cent or even below in January on the sharp fall in food prices, mainly vegetables due to better supply management. Headline CPI inflation -- the main yardstick for policy making was 5.2 per cent in December, as compared to 5.5 per cent in November.
“Some economists stressed more on the need for liquidity infusion than rate cut,” the source said.
The central bank has taken several measures to improve the liquidity situation including a 50 bps reduction in the banks’ cash reserve ratio requirements and conducting an auction of variable rate repo (VRR) on a daily basis. Yet, the deficit in the system remained high.
“Before rate cut, we need to infuse liquidity. The RBI has already initiated an Open Market Operation (OMO) purchase which should help reduce the deficit to some extent, depending on the scale of liquidity infused. However, if these measures are insufficient, currency leakage will naturally worsen the deficit. The core liquidity deficit is expected to widen to Rs 2.5 trillion by March end,” another source said.
“That said, the RBI appears to be taking proactive steps. They began with the overnight VRR (Variable Rate Repo). Going forward, we can expect more incremental liquidity infusion measures aimed at limiting the deficit. Ultimately, the extent of improvement will depend on how quickly and effectively the RBI implements these measures,” he said.
The RBI conducted OMO purchases worth Rs 10,175 crore in the week ended January 19.
A rate cut may also complicate the situation for commercial banks as the external benchmark linked loan interest rates will come down immediately though deposit rate revision may take longer, putting pressure on net interest rate margins. Banks are expecting a cut in CRR to tide over the current tight liquidity situation. Bank CEOs will meet top RBI officials for pre-policy consultations.
The source also said there was extensive discussion on the exchange rate front too during the meeting with economists. Most of them were of the view that the worst volatility of the exchange rate is likely to be over, and the rupee should be now allowed to weaken gradually to find its level.
“The RBI is letting the rupee depreciate more because they have to. Otherwise, the drain on interbank liquidity has been substantial because of FX intervention,” he said.
The rupee has depreciated 1.31 per cent in December and 0.69 per cent in January so far.
The Indian unit has weakened 2.79 per cent since October. Last week, rupee posted its biggest weekly gain since August 2023 on the back of a fall in the dollar index after US President Donald Trump refrained from immediately imposing tariffs on key trading partners.
The rate setting panel will meet during 5-7 February to review the monetary policy which could be the last of the current financial year.
[The Business Standard]
