RBI's new policy rates spring surprise

Stumping the bankers, the MPC has increased the reverse repo rate to 6% from the present 5.75%.

The demonetisation shocker, coupled with a slow remonetisation, has led to a deluge of liquidity to the tune of Rs 4 lakh crore with the bankers, but without proper avenues of safe lending to sectors that matter for triggering economic growth.

Banks, though flushed with funds, are reluctant to lend on account of the humongous levels of Non-Performing Assets (NPA — loan payments not made for a period of 90 days)  to the tune Rs 10 lakh crore.

These two critical issues have been ably addressed by RBI Governor Urjit Patel and his six-member Monetary Policy Committee (MPC) in its first bi-monthly policy announcement for the new fiscal 2017-18.

Stumping the bankers, analysts and all those who had professed status quo in the policy rates, the MPC has increased the reverse repo rate (rate at which RBI borrows from banks) to 6% from the present 5.75%.

Rest of the critical rates like the repo rate (rate at which the banks borrow from the RBI) has been kept unchanged at 6.25% and the cash reserve ratio (CRR —  share of deposit which ba­nks must park with the RBI without earning any interest) at 4%.

The rationale behind the unusual move of increasing the reverse repo rate is to induce bankers to park their surplus funds and to suck the excess liquidity by offering 25 bps interest rate, so that such “hot money” does not seep into risky, inflationary avenues like real estate and gold.

The hike in the reverse repo will further ensure the narrowing of the liquidity adjustment facility corridor between the repo rate at 6%, the reverse repo rate at 6.25% and keep the bond and the treasury bill yield curves within acceptable parameters.

Had this intervention not been undertaken, we would have experienced a dip in bond yields. This would have resulted in a flight of foreign investments (presently buoyant and positive) to better pastures as Foreign Institutional Investors (FIIs) are fair weather friends.

For a more sustained and durable action on the liquidity front, the RBI governor has placed a hybrid innovative instrument — standing deposit facility (SDF) proposal — for the Centre’s approval. The facility will enable the banks to deposit their surplus liquidity with the RBI with a decent return of around 5.5% and can be placed even for a tenure as low as 2 to 10 days, which the RBI need not back up with collateral securities. This requires amendment to the RBI Act, 1934.

The MPC is perturbed with the upside risks of inflation, especially with respect to the sticky-core and CPI inflation. Hence, it has continued with the ‘neutral’ stance without reversing to the ‘accommodative’ mode. The hawkish tone is very clear with the inflation forecast for the first half of FY 2017-18 (April-September 2017) at average 4.5% and for the second half (October 2017–March 2018) at 5%, albeit within the specified tolerance limits.

Taking precaution
The pre-emptive caution is on account of the inflation surge that is expected from the implementation of GST to be rolled out from July, impact of housing allowance from the largesse of Seventh Pay Commission, huge government spending by way of subsidies, unproductive social programmes, terrible economic impact from populist crop loan waivers, RBI buying US dollars through rupees to prevent the dollar appreciation and the
most likely possibility of another El Niño effect/ consecutive droughts in many states.

All these will rule out repo rate cut till, at least, September 2017 by which time there will be a clarity on how the issues pan out coupled with the global cues of Trump truants, the growth trajectories in China, Europe and the referendum in Italy.

The RBI governor’s statement that crop loan waiver schemes “engender moral hazard” undermining honest credit culture and affect the nation’s balance sheet, was a very strong one. An economic wrong can never be a political right.

The RBI, for the first time, has conceded that resolving the draconian NPA/stressed assets crisis requires a real understanding of the bankers’ problems, operational issues, ground realities and not just theoretical frameworks, armchair philosophy, with a plethora of complicated, unimplementable and unrealistic policies.

The RBI governor articulately said that what the system requires is well-capitalised banks, pragmatic policies and off-site professionals on the asset quality recovery (AQR) committees (as they have now come to a conclusion that there is no single recipe for NPA redress), no ‘one size fits all’ prescriptions and has drastically revised the Prompt Corrective Actions (PCA) framework, which will be operational from June.

The governor came out with a surprise announcement permitting banks to invest in Real Estate Investment Trust (REITs) and Infrastructure Investment Trusts, though within the overall limit of 20% of their net owned funds.

This move is expected to boost the funds-starved realty/construction sector and ultimately benefit the affordable housing segment. Banks should, however, exercise great caution, credit discipline and prudence while investing in REITs which are more into commercial properties and should not repeat the NPA 2.0 version!

(The writer is a Bengaluru-based economist and banker)