RBI hikes rates, but banks may hold off on raising deposit rates

India’s banks may have little immediate reason to raise deposit rates after the Reserve Bank of India’s 25-basis-point rate hike on Wednesday, as a surge in foreign-currency non-resident (bank), or FCNR(B), deposits has left the banking system flush with liquidity.

RBI governor Sanjay Malhotra said the liquidity surplus is likely to normalize by the end of the current financial year, suggesting the cushion for banks to hold deposit rates steady may not last.

“We have already seen the use of the FCNR(B) deposits as evidenced by the high growth rate, but of course, the amount is so large, we do not want them to use for overnight. They need to do their due diligence properly and take the time to use these deposits,” Malhotra said.

Announced on 5 June and implemented from 8 June, RBI’s subsidized swap window allowed banks to raise fresh three- and five-year FCNR(B) deposits from non-resident Indians and swap the dollars with the RBI at a concessional rate that effectively offset the hedging cost. The broader swap package also covered overseas foreign-currency borrowings (OFCBs) and external commercial borrowings (ECBs).

As of 18 September, the three windows had attracted $143.6 billion, with 93% through FCNR(B) deposits.

While banks look unlikely to move deposit rates, Bajaj Finance has raised its fixed-deposit rates by 15-40 basis points across tenures of 12 to 60 months, effective Wednesday. For regular depositors booking fresh deposits, the highest cumulative rate is now 7.75% for 31 to 60 months, up from 7.40%. Rates for 12 to 17 months have risen to 6.80% from 6.60%, while those for 18 to 30 months have increased to 7% from 6.85%.

“At Indian Overseas Bank, we will remain transparent with our customers as policy rates transmit through the system, while continuing to offer competitive value to our depositors,” Ajay Kumar Srivastava, managing director and chief executive officer of Indian Overseas Bank, said.

Deposit cushion

The inflows have significantly boosted bank deposits, while bank credit has also accelerated.

Motilal Oswal Financial Services estimated that system deposit growth has accelerated to 17% from 11-12% when the scheme was announced, with FCNR(B) deposits accounting for about 4.5% of system deposits.

As of 15 September, system credit grew more than 18% year-on-year, while deposits rose more than 17%, latest RBI data showed.

That deposit cushion could reduce the immediate need for banks to compete aggressively for deposits and pass on higher policy rates to savers.

The banking system’s liquidity surplus, driven by heavy FCNR(B) mobilization, peaked at ₹9.85 trillion on 15 September before easing to ₹4.7 trillion by 30 September, Nomura said in a report on 2 October.

The RBI has been draining some of the surplus through open market operation (OMO) sales, sell/buy swaps and continuous variable rate reverse repo (VRRR) operations. Its intervention in the foreign-exchange market to stabilize the rupee has also acted as a drag on liquidity.

Malhotra indicated that the surplus is unlikely to persist. Currency leakage, reserve requirements and the RBI’s liquidity operations should gradually absorb excess funds, with currency leakage alone typically accounting for ₹3-4 trillion.

“All these things, I do not expect, without giving you any numbers, that the liquidity is going to remain in such high surplus mode for a very long period,” he said.

A further increase in the cash reserve ratio (CRR) has not been ruled out, but Malhotra said it is the central bank’s least preferred way of absorbing liquidity.

“We expect that over the coming weeks, the RBI is likely to continue with sell/buy swaps, VRRRs and if required further OMOs to absorb excess liquidity in the system and do not expect any hike in CRR rate,” HDFC Bank said in a report on 7 October.

The rise in currency in circulation with the start of the festive season, along with continued FX intervention, could also help reduce the liquidity surplus, the report said.

Lending rates adjustment

The effect of Wednesday’s rate hike on lending rates is likely to take longer to emerge. Deputy governor Swaminathan J said some moderation in credit growth should be expected, with bank credit currently growing at 18-19%, well above its longer-term sustainable range of 12-14%.

“As these rates transmit, as we have seen, it typically takes about a couple of quarters for transmissions to materialize,” Swaminathan said, adding that moderation in credit growth from current levels would not necessarily be a concern.

“But the moderation from (the current) 18-20% is not bad and will be adequate enough to support growth,” he said.