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Welcome rate cut by new team in RBI

Last Updated 04 October 2016, 18:42 IST

Debutants Urjit Patel, the new RBI governor and the six-member Monetary Policy Committee (MPC), have granted Dasara and Deepavali gift in their maiden monetary policy announcement by reducing the repo rate by 25 bps.

The repo rate – the rate at which the banks borrow from the RBI – now stands at 6.25%, reverse repo rate which RBI borrows from banks at 5.75% and the cash reserve ratio – the share of deposits which banks must park with the RBI without earning any interest – remains unchanged at 4%.

The reduction in rate has been welcomed and well received by all quarters – government, corporates, consumers and bankers. The stage was ideally set for a rate cut.

The Consumer Price Index (CPI) inflation in the comfort zone of 5%,  well within the RBI target, substantial easing of food inflation, favourable monsoon with above 97% in most parts of the country leading to record sowing, core sector growth at 3.2% in August, current account deficit (CAD) as low as 0.1% of GDP (record low in nine years) during the first quarter April-June have prompted all the six members of the MPC to unanimously vote for 0.25% cut in the repo rate.

The front loading of reduction in rate by the governor even before assessing the sustainability and durability of the reduction in inflation and wide impact of monsoon across different states over the next three months, is with the sole purpose of giving boost to the economy in general and the consumer market in particular keeping in view the festival months till December.

However, the MPC in its commentary has cautioned on the upside risks on inflation and on the potential cost push factors on account of the HRA impact of the Seventh Pay Commission largesse and the GST impact on inflation, which can spike the CPI by an additional 1.5%.

The governor made it clear that the RBI will work in tandem with the government and will provide ample liquidity to boost the economy which is poised to achieve GDP of 7.6% during the present financial year. The cautious optimism is in spite of the prevalence of global gloom, possible interest rate hike by the US Federal Reserve in December which can lead to the flight of foreign investment to better pastures as Foreign Institutional Investors are fair weather friends,  border tensions and the outcome of the US elections.

The RBI has committed to provide adequate liquidity for redemption of Foreign Currency Non Resident (FCNR) of $26 billion which will come for repayment during September-December 2016, funds required for telecom spectrum auction and festival season through continued open market operations. The RBI, which has already pumped in Rs 1 lakh crore, is geared up to supply an additional Rs 1 trillion to support the above fund requirement.

Anaemic transmission
Urjit Patel was harsh on the banks for the anaemic transmission of earlier rate cuts to the corporates, industries, borrowers of housing loans and personal and consumer loans. Though 150 bps has been reduced from January 2015 till April 2016, the effective transmission to the customers is hardly 75 bps.

The governor’s caution should drive the banks to immediately take suitable measures to pass on the rate cut benefits to the existing clients, start aggressive lending to the industries and corporates at competitive rates to kick-start the growth in the economy.

The pumping of funds will trigger the investment cycle leading to accelerated economic growth through the multiplier effect. All the favourable macros and micros – inflation under leash, good monsoon, adequate forex reserves, CAD and fiscal deficit under control, favourable international crude prices of less than $50 per barrel, exchange rate of Rs 66.47 per dollar, GDP growth at 7.1%, will be a dampener and will spoil the great Indian “economic party” if banks do not resolve their NPAs/stressed asset issues on a war footing.

The elephant in the room is the NPAs of more than Rs 8 lakh crore and not being able to dispose the acquired stressed assets under the SARFAESI Act on account of higher auction reserve prices or lack of bidders.

The governor was categorical when he said that RBI will be “firm and pragmatic” in dealing with the banks on NPAs. Patel lamented that five sectors – infrastructure, textiles, steel, telecom and power – contribute to 61% of stressed assets causing drag and drain on the economy.

He was unhappy on the “resolution” success rate (identification, recording, reporting and resolution of NPAs) of cleaning up of the banks’ balance sheets, deadline of which is March 2017, which looks a tall order.

The governor and the MPC are in accommodative mode when it articulated that the real neutral rate can even be 1.25% (presently 1.5%) which gives headroom for further rate reduction. The difference between the repo rate and the CPI inflation should be 1.25%. There is scope and window for further reduction of 25 bps in the next monetary policy review schedule for December 6, 2016.

(The writer is a Bengaluru-based banker)

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(Published 04 October 2016, 18:42 IST)

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