RBI likely to nudge banks to raise saving account interest rates

The swift change in global risk appetite and low volatility provide comfort to the RBI on lower risk of financial instability. This also, thus, reduces the need to conduct open market operation (OMO) sales as a way to depict implied bias for higher rates and higher risk premia to the world

The Reserve Bank of India (RBI) may softly prod banks to nudge up Saving Account (SA) rates, while ruling out any explicit policy directive to re-regulate such rates, when the RBI governor addresses media on December 8, post three-day MPC meeting, which kick-started on December 06.

A benign global narrative, tighter system liquidity and easing core inflation despite stronger growth, will be the backdrop of MPC meeting. The swift change in global risk appetite and low volatility provide comfort to the RBI on lower risk of financial instability. This also, thus, reduces the need to conduct open market operation (OMO) sales as a way to depict implied bias for higher rates and higher risk premia to the world.

The policy focus then reverts to the domestic narrative, wherein resurgence of food inflation and slow policy transmission will be the key.

Talking to Bizz Buzz, Madhavi Arora, lead economist, Emkay Global said, “We expect the RBI to softly prod banks to nudge up SA rates, while ruling out any explicit policy directive to re-regulate such rates.”

Since the last MPC in October 2023, financial markets have been broadly pushing up asset prices and reversed around half of the bond-yield spike of the last quarter. This is backed by higher market conviction of a wider runway for a soft landing and the Fed’s terminal state (a US Goldilocks scenario), with recent policy communication suggesting that the risk of further tightening has significantly receded. Underlying this rise in risk appetite, the rates market now incorporates relatively high probabilities of easing by both, the Fed and ECB, next quarter, led by better-than-expected recent inflation reports.

Analysts feel that factors, such as inflation trends taking time to discern, and easier financial conditions feeding back into demand, may be slowing any move towards the key DM central bank easing next year.

However, a swift change in risk appetite and low volatility in risk assets have given comfortable breathing space to emerging markets, including India, on offering higher risk premia. This contrasts with Q3CY23 –of the RBI’s October meeting, when UST10Y was at 4.8 per cent and would touch 5.0 per cent within a couple of weeks, with commodity prices also having moved higher.

A consistent move towards a tighter liquidity regime has been the RBI’s policy prerogative, as per the “withdrawal of accommodation” stance. Even as the RBI reversed the I-CRR in October, it showed concern on the skewness of liquidity distribution in the banking system, with a blunt mention of OMO sales as an option to tighten liquidity. We see limited merit in the need for OMOs in coming months, as: i) the OMO sales noise was partly to reflect implied bias for higher rates, to be able to offer fair risk premia in the global context, as one of the ways to anchor FX.

According to Arora, “We note that the India-US 10Y spread has widened to 300 bps after having seen the decadal lows of 240 bps in mid-October.”

Additionally, global risk appetite has improved and UST yields have changed gears, while Indian Rupees has stayed well-anchored; ii) the spread between weighted call money rate and repo rate has since widened (17bps in November vs 2 bps in September and the system has remained in the repo mode, our estimates suggest system liquidity is likely to stay near-neutral in coming months, helped by FPI flows and lower CIC, but will tighten by end-FY24 despite FX swap reversal, she said.

On the domestic front, activity data continues to be resilient, while fiscal behaviour has seen front-loaded spending. The consequent growth sheen in H1 could lead to the RBI raising its FY24 growth forecast by 20-30 bps. Inflation has again been quite volatile in recent weeks, with perishables (specifically onions and tomatoes), pulses and spices showing quite strong upward momentum. This could push the Q3 CPI inflation average to 5.6 per cent, in line with the RBI’s forecast. While this will add caution to the RBI’s tone, especially as non-perishable items are showing a consistent uptrend, this trend stands in strong contrast to easing core inflation – having retraced to a 3.5Y low, and will likely average a tad below 4 per cent in the rest of FY24. The RBI’s consistent discomfort, with runaway growth in unsecured loans, ultimately resulted in tighter regulatory norms in October. In the same vein, the RBI has voiced its dissent about lower or less than 4 per cent and near-stagnant Saving Account deposit rates for many banks, including large banks vs. a 250b bps increase in repo rate.

The RBI also flagged the reduced spread of new loan rates over the repo rate, all of which is moderating the extent of the transmission.

While experts believe the RBI should/would not intervene in banks’ commercial decisions, we do not rule out the regulator softly prodding banks, instead of re-regulating the SA rate via any official directive. Higher SA rates could hurt growth/earnings of banks with higher SA deposit share, unless mitigated by the increasing floating lending rates.