You hear today that the RBI is about to normalize rates. Yes, they will normalize; they have already given hints and will be launching it in a while. It could begin on December 8, the date of the next review meeting of the Monetary Policy Committee, the panel responsible for deciding interest rates. Take the blow.
To begin with, this is called rate normalization, not rate hikes. Even though, at first glance, interest rates will be raised, there is a reason the industry calls it normalization. During the pandemic, from March 2020, the economy experienced a slowdown. To combat this, the entire nation has taken emergency action, including the Reserve Bank of India. For the RBI, the emergency measures were:
â¢ Reduce interest rates to the extent warranted, so that money is available cheaper. Cheaper money flows faster because people have an incentive to take out loans, which makes the wheels of the economy move much faster;
â¢ Inject a lot of money into the banks, so that the banks have an incentive to grant loans.
The impact of these measures was limited as demand for loans was weak as the economy was slowing, recovering and gaining momentum. The background is that interest rates have been lowered to emergency levels, which cannot be sustained for a long time. Now that the economy is normalizing, rates must also be normalized, which is why we are not talking about rate hikes as such.
To get an idea of ââlow rates, there is a âsignalâ repo rate, the rate at which the RBI would lend funds to banks for a day when needed. This rate is currently 4%, which is the lowest on record. Then there’s a reverse repo rate, the rate at which banks park their cash flow with the RBI, which is currently 3.35%. It is also the lowest on record, but for a brief phase in 2009.
To be a bit technical, in the interbank demand money market, the overnight rate, as it is known for overnight borrowing / lending, is supposed to be in the repo-reverse repo range. Currently, due to the influx of cash injected by the RBI, the overnight rate is at the lower end of the band at 3.35%. For a perspective on the extent of liquidity with banks, let’s go back to the post-demonetization period. Money was pouring into the banks, about ??15,000 billion. The excess money, which the banks parked with the RBI through reverse repurchase agreements, was a little higher than ??5,000 billion. In this phase of pandemic RBI support, the excess money with the banks is double the post-demonetization surplus.
What will be the steps towards standardization that we are discussing? The inflow of liquidity to banks will be gradually filled, so that the overnight rate will gradually rise from the low band (reverse repo) to the high band (repo). This will not cause a shortage of funds from banks for lending purposes. A reasonable surplus is enough, the flood is useless. Then the reverse repo will be raised, probably on December 8th itself, so that the band (3.35% to 4%) normalizes, while keeping the repo rate at the same level for now. The last step, to be taken in a calibrated manner, consists in increasing the rate of âsignalâ repurchase agreements. Note, even when the RBI is following or completing the process, interest rates will still remain favorable to the growth of the economy. Only from low emergency levels will it be adjusted upward to reach normal support levels.
What is the implication for you and me? The RBI is responsible for balancing interest rates. On the one hand, it must be low enough to support the growth of the economy, and on the other hand, it must be high enough to be remunerative for savers. Given the level of inflation over the past two years, real bank deposit rates are negative. Although inflation is now expected to slow, deposit rates need to be adjusted upward. So over time things should improve a bit for savers, especially seniors with no active income. The scope will remain for lending rates on the softer side; banks are offering 6.5% variable rate home loans this holiday season, along with their margins, while the latest RBI repo rate cut was in May 2020. As economic growth accelerates , loan withdrawal is also expected to accelerate, notwithstanding the slightly higher than current rates.
Joydeep Sen is a business trainer and author.
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