Cheaper Money
By lowering the bank rate, not only has the RBI forced banks to reduce lending rates by cutting deposit rates for up to a year by 1 percentage point, but other rates linked to the bank rate like the interest rates for export credit have also fallen by the same percentage, which should give an impetus to export firms.
Part of the problem up to now has been that some of the cuts in the prime lending rate have been notional and have not been translated into lower borrowing costs for companies. Many of the nationalised banks which have brought their prime lending rates down to 14 per cent after the last credit policy have not been too happy to lend to the corporate sector at these largely notional rates. For the other domestic and foreign banks, the average prime rate is still around 16 per cent very high indeed, when the inflation rate is under 6 per cent.
The latest cut in rates will bring the overall rates down in the banking sector even if the banks choose to maintain their spreads. This may force banks to re-examine their risk-reward dynamic and start lending more to corporates. Hence more companies will be able to avail of credit at a lower rate.
Currently, the high rates notwithstanding, credit to the corporate sector has been growing slowly. The decline in credit during the easy season up to the end of May was only Rs 828 crore, considerably less than the decline last year of over Rs 5,784 crore. If the banks investments in bonds and debentures are added to this years drop, there has really not been a decline in the flow of funds to the corporate sector.
However, the banks may face some worries on the deposit front. An 8 per cent interest rate for maturities of upto one year represents a real return of only 2 per cent. And though the banking systems deposits have been growing at a fair clip, especially with depositors switching from the suddenly suspect non-banking financial companies to the safer haven of banks, banks may find that their deposit profiles tend to get longer and, therefore, more expensive. Some of this money may also start finding its way into other higher yielding instruments, like bonds or even equities. And that, from the economys point of view may not be a bad thing at all.