Last-mile transmission a big hurdle to policy rate cut
Mumbai: What’s holding back India’s central bank from cutting policy rates? Apart from the pace of price rise that is yet to align with Reserve Bank of India’s (RBI) target of 4%, there is another factor at play — transmission of past repo rate actions into lending rates. The monetary policy committee (MPC) of RBI raised the repo rate by 250 basis points (bps) between May 2022 and February 2023.
It has since kept the key policy rate unchanged, looking for ‘durable’ signs of disinflation and a fuller transmission of rates. However, between the start of the tightening cycle in May 2022 and till February 2024, the weighted average lending rate on fresh loans by banks increased by 185 basis points (bps), showed data in RBI’s half-yearly monetary policy report released last week.
The last mile of transmission, akin to the last mile of disinflation, seems to be the hardest for lenders as over 40% of system credit is not linked to the repo rate. Although loans linked to external benchmarks — mostly the repo rate — have been repriced, those linked to the marginal cost of funds-based lending rate (MCLR), an internal benchmark, are lagging the rate hikes.
While the external benchmark rate would change as the repo rate moves, the MCLR depends on the cost of deposits. To be sure, retail and small business loans are linked to external benchmarks, and corporate loans are still on the MCLR.
The external benchmark rate has moved in tandem with the repo, but the median one-year MCLR has lagged and gone up 155 bps between May 2022 and March 2024. “Today, we have a situation where banks have selectively increased deposit rates because there is a lot of uncertainty on when the cycle will turn," said Madan Sabnavis, chief economist, Bank of
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