HomeFinance NewsCOVID-19 impact: A look at interest rate transmission so far to infuse liquidity

COVID-19 impact: A look at interest rate transmission so far to infuse liquidity

With the outbreak of the COVID-19 pandemic, the central banks around the world have infused massive liquidity in the markets to counter the economic fallout. The Reserve Bank of India (RBI) also has announced a slew of measures over a period of time to tackle the distress.

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By Ankit Gohel  July 10, 2020, 9:05:11 PM IST (Updated)

COVID-19 impact: A look at interest rate transmission so far to infuse liquidity
With the outbreak of the COVID-19 pandemic, the central banks around the world have infused massive liquidity in the markets to counter the economic fallout. The Reserve Bank of India (RBI) also has announced a slew of measures over a period of time to tackle the distress.


The RBI has lowered the repo rate to 4 percent in various tranches, which stood at 6 percent in April 2019. The total reduction in FY20 was 160 bps. However, there is an argument that the transmission of the interest rate is not as swift as it should be.

The lending rate, which is defined by the MCLR or base rate or more recently the accepted benchmark, is also linked to the deposit rate, which has to be altered first as it goes into the cost of funds.

“As loans get repriced immediately, while only new and renewed deposits go at the new rate, the impact on average cost of deposits would come with a lag. Therefore, there is a theoretical reason for the transmission to be slow which can take a period of over six months provided banks lower the deposit rates,” CARE Ratings said in a report.

In order to gauge the state of liquidity, one may look at the markets as the government bond probably is the best indicator to use which is risk-free.

The agency noted that the 10-year GSec yield was 7.24 percent as of last week of March 2019. It came down by around 60 bps by March 27, 2020. The response rate (change in interest variable to change in repo rate expressed as %) was hence 70 percent.

“Subsequently, till May 22 the response was more than expected at close to 140 percent as the yield came down by 100 bps to 5.75 percent in response to the 75 bps cut in repo rate. However, in the third stage of 40 bps cut in the repo rate on May, the yield has remained more or less unchanged in the same range,” the report said.

The prospects of higher government borrowing and more paper being issued were responsible for intransigence in yield movement, according to the report.

On the lending side, banks have responded with a good deal of alacrity as seen in the decline in the weighted average lending rate (WALR) on fresh loans. The 160 bps cut for 14 months had WALR coming down by 122 bps which is quite significant with the response of WALR on fresh loans being above 75 percent.

Source: CARE Ratings


Deposit rates of banks too have moved down though not to the same extent. A total of 77 bps decline in deposit rates was recorded against 160 bps cut in repo rate during the 14-month period. There has hence been a transmission rate of just about 50 percent in average deposit rates.

Source: CARE Ratings


“Monetary policy action hence can be said to have been quite effective in terms of transmission and depending on the evolving situation can be expected to be play an important part in guiding the direction of interest rate movements,” CARE Ratings said.

However, median MCLR may not be an effective measure of comparison relative to the WALR, which is the actual average that considers the size of loans too. For the entire period, the MCLR for one year was down by 104 points in response to the 200-bps cut in repo rate.

Source: CARE Ratings
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