Unreal repo rates hurts savers

Unreal Repo rates hurts savers badly

Record Borrowings: Central and State Governments made record borrowings of Rs.21.49 lac cr. in the financial year 2020-21.                            (Rs. in cr.)

Government	Gross	Net
Central	13,70,324	11,43,114
State	7,78,175	6,32,254
Total	21,48,499	17,75,368

For FY2021-22, the indications are that the borrowings might be still higher.

How this was made possible? With Reserve Bank of India (RBI) proactively involved in ensuring adequate liquidity in the financial sector, one is under the impression that the record borrowings of the state and centre was made possible only due to the slew of liquidity measures initiated by RBI. Monetary Policy Report of RBI also says that its initiatives since Feb 2020, resulted in availability of Rs.13.61 lac cr. of liquidity to the financial sector. But the impression gained is only partly true. The following table illustrates the point that not all liquidity that was made available was used by the financial players, when they invested in the bonds and securities that were part of government borrowings.                                                                                                                  (Rs. in cr.)

Liquidity Measures	Amount made available	Outstanding as on 26.03.201/ Utilised amt.
LTRO	2.0 lac	0.02
Variable rate repo	2.25 lac	Negligible
SLF for PDs	0.07 lac	*Under FIs
CRR Cut	1.37 lac	1.37 lac
MSF (dip 1% in SLR	1.37 lac	negligible
TLTRO	1.0 lac	0.67
TLTRO	0.50 lac	0.08
Net OMO	1.50 lac	1.50@
SLF for MF	0.50 lac	*under FIs
Refinance to FIs*	0.75 lac	0.32
SLF for NBFCs	0.30 lac	*under FIs
56 day term repo	1.0 lac	negligible
On tap TLTRO	1.0 lac	0.05
Total	13.61lac	4.01

@gross OMO purchases in 2020-21 – Rs.3.13 lac cr.

While RBI should be given credit for (i) cutting the CRR by 1% and made available Rs.1.37 lac cr. in the hands of the banks, (ii) its net OMO purchases resulting in liquidity of more than Rs.1.50 lac cr. and (iii) its constant intervention in the forex market to purchase dollars equivalent to Rs.5.60 lac cr. (upto Jan 2021), the other liquidity measures were not really used by the commercial banks, as they were flushed with funds, thanks to the depositors. The following table illustrates how a significant portion of the borrowings of the centre and state governments were met from the banking system:          

                As on 26.03.2021              (Rs. in cr.)

Deposit Accretion in banks	13.88 lac
Less Growth in advances	4.27 lac
Net Deposit accretion	9.61 lac
Net OMO purchases	3.13 lac
Forex purchases by RBI(upto Feb 2021)	5.60 lac
CRR cut	1.37 lac
Through various liquidity measures*	1.12 lac
Total	20.83 lac

In this regard, RBI derives its strength to conduct OMO purchases and intervene in forex market to purchase excess dollars, mainly on account of the resources available in its hands in the form of ‘deposits from banks’ for CRR compliance (3% of NDTL) and ‘deposit-others’ mainly comprising the liquid funds deposited by the banks under reverse repo#.  As per the annual report of 2020-21 of RBI, the deposits under the above two heads constituted 96% of the total deposits held by RBI (Rs.14.91 lac cr.).

(#Two other major resources – ‘notes in circulation’ (Rs.28.27 lac cr.) and ‘risk provisions’ (Rs.13.82 lac cr.) are mainly invested in gold and foreign securities/deposits as per norms that accompany notes issued and risk provisions)

Depositors in for a raw deal: So, the depositors in the banks, helped not only their banks in subscribing to government borrowings, but also to RBI for successfully conducting its liquidity initiatives including OMO purchases, forex interventions in  the market. However, the depositors got a raw deal in  deposit rates due to the combined actions of both the regulator and the government. Let me explain:

Ø  Inflation versus Repo rates: It is generally held that, whenever the inflation is on the rise, repo rate (the rate at which banks borrow money from RBI for liquidity mismatches) will be increased to bring down money supply. Converse will be the action, when inflation is lower: But the reverse happened in the last two years as revealed by the following table.

Inflation – year wise	Per cent	Repo rate- date wise	Per cent
2017	2.49	02.08.2017	6.0
2018	4.86	06.06.2018 01.08.208	6.25 6.50
2019	4.76 (Shot up since aug 19 & reached 7.35%  in dec 19)	07.02.2019 04.04.2019 06.06.2019 07.08.2019 04.10.2019	6.25 6.0 5.75 5.40 5.15
2020	6.2 (was in excess of 6.2% since June 2020 with peak of 7.61% in Oct 2020)	27.03.2020 22.05.2020	4.4 4.0
2021  (RBI est.)	5.1 @6.3% in May 2021	No change	4.0

 

Ø  RBI is mandated to keep the inflation at 4% with a +/- 2 per cent tolerance band. The common man understands that if the inflation is above 4% but within the tolerance level, then the RBI will indicate thro policy rate (either an increase or maintain status quo) its intention to reduce the inflation to the mandated level and vice versa, when the inflation is below mandate level.  But ever since 2019, the regulator appears to have placed more importance towards growth than on achieving the inflation target.

Ø  Bench mark lending rates of banks, which were internally linked to cost of funds, were replaced by external bench mark rates linked to policy rates. It was made mandatory, since October 2019, (much prior to COVID impact since March 2020), that banks shall link their new loans to the external bench mark rates.  As the policy rates were on the decline (135 bps in 2019 and 115 bps in 2020), the banks per force had to reduce their loan rates linked to external bench mark rates. Instead of arriving at the lending rates, based on cost of funds, banks started the reverse process of adjusting the deposit rates to suit lending rates.

Ø  The median term deposit rates dropped by 205 bps and the actual deposit rates had come down by more than 150-200 bps in most of the banks since October 2019. Worse, savings deposit fetches only 2.7- 3.0% now (as against 3.5-4.0% enjoyed earlier)

 ØConsidering the inflation rate since second half of 2019, the real rate of return is negative if one is a tax payer and marginal if he is a non-tax payer (the average fixed deposit interest rate in most of the banks is 5.5% - from 7.25 to 7.50% earlier and the estimated inflation for current year is 5.1%)

Who gained at the cost of bank depositors:

a.      The Government: (both central and state): 10 year G-Sec, where the yields were ruling at 7.59 in Feb 2019, is now carrying a yield of 6.02, a reduction of 157 bps.  The weighted average yield of dated g-sec had dropped from 7.77% to 6.16%, while the weighted average maturity has gone up from 14.7 years to 16.15 years. It is strange that the government could cut its cost, when it borrowed more.

b.     Corporates, which were above investment grade: While AAA and AA rated corporates reduced their cost by more than 300 bps as on 31.03.2021 as compared to the rates as on 31.03.2020, BBB rated entities could reduce it by more than 200 bps.

c.      Short term money market instruments: The reduction is over 300 bps., especially for persons raising short term CPs (3 month period)

d.     Bank Borrowers: Secured loans came down by 178 bps for fresh loans and 98 bps for outstanding loans in select categories. 

e.      Bankers: In the year marked by COVID Pandemic and incessant lock downs, credit growth was muted and lot of stress was expected in the loan assets.  However, almost all banks have shown a positive net interest income in their results for FY 2020-21, mostly on account of reduction in interest expenditure, in spite of the fact that double digit growth is recorded in total deposits.

The loser side is not confined to bank depositors alone:

Insurers, PF and Pension Funds: As per the report of RBI, Commercial Banks (app. 40%), Insurance companies (25-30%) and PF/Pension Funds (10-20%) subscribe to the maximum in the central and state government securities, both under issued category and outstanding. As per the investment pattern, they need to keep 45-50% of their total investments under sovereign securities and 35-45% in AA & above rated instruments/bank deposits. The reduction in yield on the government securities (150 bps) and rated instruments (300 bps), with no decline in inflation,  will have a cascading effect on their ability to pay, as their liabilities are fixed (guaranteed returns in respect of insurance policies, annuity pensions are fixed and pension is fixed in respect of defined benefit scheme, etc.). EPFO and accredited PF funds might find it difficult to maintain the average interest of above 8.5% paid in the last few years.

Small Savings Scheme Investors: The rate of interest offered on the various deposit products under the scheme are linked to the average g-sec yield of corresponding maturity. The average yield on 10-year g-sec, which was ruling between 6.60 to 6.70 between August 2019 to January 2020 came down to 6.13 in March 2020, consequent to reduction of repo rate by 75 bps in March 2020. Though the reduction in repo at that time was to take care of lock downs resulting from COVID scenario and had nothing to do with inflation level prevalent at that time, the government announced reduction in small savings scheme interest rates (100 to 140 bps) with effect from 01.04.2020. Even the present rates are considered excessive (Monetary Policy report April 2021, RBI), as the formula for arriving at the scheme’s rates is linked to the corresponding g-sec yield.

Going forward:

1.     Inflation has come to stay, if we consider the food, petrol and diesel prices – major components of CPI.  9% of the population in the age group of above 60 category, who depend on interest earnings only. Even in the age group of 21-60 (41% of the population), job losses, salary cuts, cessation of business, are quite high. Keeping the repo artificially low at 4.0% for a longer period (already more than one year) will hurt the retail savings in the long run.

2.     Policy rate, viz. the repo rate should be the target rate to be achieved in respect of money market instruments. But ever since the spread between repo and reverse repo rate was raised to 65 bps, the rates of money market instruments hover around reverse repo rate. The spread should be reduced to 25 bps, so that real interest rate on money market emerge.

3.     OMO should be used for liquidity management and not for managing yields on government securities.

4.     Unlike other countries, even today majority of the banks in India lend money out of deposits canvassed and not from outside borrowings. The depositors’ confidence in the banking system, arising out of sovereign guarantee and deposit insurance, is unlimited.  The depositors need positive real return on their deposits.

5.     Social security scheme providers like insurance, PF & pension funds should be able to meet their liabilities, which are fixed, without any difficulty.  This is possible, only when the return from risk free/risk mitigated investments like g-sec, bonds etc. reflect inflation adjusted positive returns.

6.     Small savings scheme interest rates, which are now linked to the corresponding g-sec rates, should be linked to the average inflation/g-sec rate whichever is higher.

7.     RBI has not resorted to printing of money as it might spiral inflation further. But it has a role to play to apprise the government that higher borrowing shall accompany higher coupon rates to compensate the suppliers of money, mainly the retail investors, at least to meet the inflation cost.

 

V.Viswanathan

11^th June 2021

Sources:

1. Monetary Policy Report April 2021

2. MPC Statements from 2017 to 2021

3. Government Memorandum on Small Savings Scheme

4. Money Market Operations Statement of RBI as on 26.03.2021

5. Weekly Statistics Supplement 02.04.2021

6. Annual Account Report RBI 2020-21

7. https://www.statista.com/statistics/271322/inflation-rate-in-india

8. https://www.macrotrends.net/countries/IND/india/inflation-rate-cpi

9. https://www.inflation.eu/en/inflation-rates/india/historic-inflation/cpi-inflation.

10. https://www.inflation.eu

11. https://tradingeconomics.com/india/consumer-price-index-cpi