×

Hopes rise over RBI's lending-boosting efforts

The Reserve Bank of India (RBI) has maintained an accommodative policy stance for well over a year now but its efforts have had a limited impact on spurring bank lending to consumers. Now, economists hope the measures announced on Tuesday will prove different.

Despite slashing interest rates by a total 125 of basis points in 2015, the RBI has been hamstrung by the limited pass-through by banks. Commercial lenders have implemented only about half of the rate cuts, blaming tight liquidity conditions and deteriorating asset quality. Non-performing loans (NPLs), or bad loans, spiked by nearly a third to $60.3 billion late last year, according to Reuters.

On Tuesday, the central bank lowered the rate at which it lends money to banks—called the repo rate—to a more than five-year low and announced new steps to prod banks to pass on the full benefits of monetary stimulus to the wider economy, revealing its commitment to the issue.

Governor Raghuram Rajan cut the marginal standing facility rate, i.e. the amount banks can borrow from the RBI for emergencies, by 75 basis points and said he will ensure liquidity conditions are closer to neutral instead of the previous standard, a 1 percent deficit of net demand and time liabilities (NDTL).

He also introduced a bevy of liquidity-boosting measures to address banks' complaints, including a 5 percentage point reduction of the cash reserve ratio, the minimum amount of deposits that banks are required to park at the RBI.

"These measures will ensure that the easy policy stance percolates to the real economy and materially lowers financing costs," said Radhika Rao, DBS economist in a Wednesday note, echoing similar sentiments by Goldman Sachs.

Tuesday's developments will provide support to growth by easing liquidity conditions and facilitating transmission of policy rate cuts, agreed Morgan Stanley in a Tuesday report.

But some strategists still remain cautious.

"It should help at the margins," Shilan Shah, India economist at Capital Economics, told CNBC's "The Rundown." He expects banks will still continue the status-quo of passing on only half of the announced rate cut to consumers.

The RBI faces problems with its transmission mechanism due to the fact that banks are hesitant to lend, Shah explained. Rising NPL ratios over the past four years have put pressure on balance sheets so banks are reluctant to pass RBI rate cuts onto consumers, he said.

The slow loan growth at banks threatens to derail Indian Prime Minister Modi's economic expansion efforts. Soggy lending can imperil India's economic recovery given the importance of consumer sectors.

Rajan said on Tuesday that factors including the new marginal cost of funds based lending rate (MCLR) and Tuesday's measures should improve transmission going forward. The MCLR is a new methodology of setting lending rate by commercial banks that was introduced in December.

Raghuram Rajan, The Reserve Bank of India (RBI) Governor.
Danish Siddiqui | Reuters
Raghuram Rajan, The Reserve Bank of India (RBI) Governor.

Economists widely agree that monetary policy alone can't help reinvigorate India's banking sector.

"They've done as much on the monetary policy front as they can. It's a structural story: land reform, bank reform, tax reform. Modi now has to deliver, you can't do it with monetary policy alone," noted Paul Gruenwald, chief economist, Asia Pacific, at Standard and Poor's Ratings Services.

Among the measures Modi's administration has announced so far include a roadmap for consolidation among public sector banks and warnings of severe penalties for corporate defaulters following the alleged charges behind liquor tycoon Vijay Mallya.

The RBI has demanded banks recognize bad debts by March 201, and the government has promised an injection of 250 billion rupees (nearly $4 billion) into these banks for the current fiscal year.

But the government must infuse more capital into the sector, echoed Shah.

"Until we see that, we're going to continue to see problems with the transmission mechanism," he said.

—Follow CNBC International on Twitter and Facebook.