Doubts over effectiveness of monetary policy as previous cuts failed to pass – The New Indian Express

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Express press service

Interest rate hikes are headed our way, but ironically previous rate cuts have yet to fully transmit, raising doubts about the effectiveness of monetary policy transmission. Of the 250 basis point reduction in the policy repo rate since February 2019, the weighted average lending rates (WALR) on fresh and outstanding loans in rupees fell by only 213 basis points and 143 basis points. basis respectively.

Repo and reverse repo rates were last cut in May 2020 and despite a nearly two-year lag, the pass-through is incomplete, especially for existing borrowers, where the shortfall reaches 107 basis points or 1.07%. The impending rate hike cycle means that this group of borrowers may never be able to take full advantage of the ultra-low rate regime that is about to expire.

Discouragingly, the central bank’s trials and tribulations to improve transmission date back three decades, but have yielded little. Beginning with Prime Rate (PLR) in 1994 through Benchmark PLR (BPLR) in 2003 through to Prime Rate in 2010 and MCLR in 2016, the RBI has periodically attempted to improve monetary transmission and give transparency in the process of setting loan rates. .

The current system, namely the External Benchmark Rate (EBR), was rolled out in October 2019, and a recent RBI study notes that pass-through has improved and the EBR has accelerated pass-through even to linked loans. to the MCLR, as changes in benchmark rates have led banks to proactively adjust their deposit rates to protect their margins, thereby improving the pass-through to overall lending and deposit rates.

Other data supporting this view include the increase in the proportion of variable rate loans linked to the EBR. From 28.6% in March 2021 of total loans, EBR-linked loans increased to 39.2% in December 2021. The share of MCLR-linked loans is still the largest at 53.1%, but the sustained decline in MCLR and the resetting of these loans to lower rates resulted in WALR easing on outstanding loans. WALRs on personal loans and MSME loans also declined significantly over the October 2019-February 2022 period. The decline was largest for personal loans at 222 basis points, followed by car loans at 208 basis points and loans to MSMEs at 194 basis points.

The effectiveness of monetary policy depends on the rate at which changes in policy rates are transmitted to the real economy. In India, the pass-through was smooth at the short end of the maturity spectrum, while the pass-through to bank lending and lending rates remained relatively slow. There is evidence of an asymmetry in the pass-through of changes in repo rates to banks’ lending and deposit rates.

At first glance, the impact of policy rate changes on term deposit interest rates appears to be greater than on lending rates. Term deposits constitute only 56.2% of aggregate deposits in March 2022, while current account and savings account deposits constitute 9.8 and 33.8% respectively. Current account balances earn no interest and are therefore largely insensitive to changes in policy rates. The transmission rate to savings accounts is generally moderate and modest compared to term deposits. Thus, if deposits in current accounts and in savings accounts are taken into account, the impact of rate changes is not as acute.

Despite a 2-year lag, Pass-through incomplete
Repo and reverse repo rates were last cut in May 2020 and despite a lag of nearly two years, the pass-through is incomplete. The impending rate hike cycle means this set of borrowers may never be able to take full advantage of the ultra-low rate regime that is about to expire.

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