RBI credit policy: Pass on benefits

The governor has made it explicitly clear that reduction in rate is not the panacea for growth.

RBI Governor Raghuram Rajan has reduced the repo rate (the rate at which banks borrow from the RBI) by 25 basis points at 7.25 per cent- the third reduction this year. The decision is to trigger economic growth.

The favourable macro economic indicators of inflation based on consumer price
index (CPI) at 4.87 per cent, GDP at 7.3 per cent and fiscal deficit at 3.99 per cent of GDP as in March, 2015 at Rs 5.01 lakh crore facilitated the RBI to reduce the rate with the
fond hope that commercial banks will come out of their shell and start lending to infrastructure and housing projects aggressively.

The cash reserve ratio at 4 per cent (share of deposits which banks park with the RBI, without earning any interest) and the Statutory Liquidity Ratio at 21.5 per cent (percentage of deposits that the bank has to maintain in the form of gold, cash, approved securities) are left untouched by the RBI. Most banks wanted reduction in the CRR as it would have led to direct monetary transmission. Even 50 basis points reduction in the CRR would have helped the banks pump Rs 45,000 crore into the market lending.

However, Rajan has not touched the CRR since banks are flush with liquidity and it is their reluctance to lend on account of the fear of high NPAs at 12 per cent of the total bank advances - amounting to almost Rs 5 trillion.

This is validated by the dismal performance of the eight core sector industries in April 2015 at (-) 0.4 per cent. These sectors are crude oil (-2.7 per cent), natural gas (-3.6), refinery products (-2.9), fertilisers (-0.04), steel (0.6), cement (-2.4), electricity (-1.1) with only coal being the exception with growth of 7.9 per cent.

This proves that the benefit of earlier two rate reductions of the RBI has not been passed on to the industries coupled with government not doing significantly in overcoming the supply side constraints like facilitating easy licensing policies, providing land for industries at affordable prices, uninterrupted power supply, employment generation and other infrastructure facilities so as to attract foreign investment and promote domestic entrepreneurship.
The governor, being dovish in action, has given strong signals to both the banks and the government by being hawkish in terms of revising the inflation and growth guidance, which is a googly. The inflation trajectory has been revised upwards to 6 per cent and the economic growth in terms of Gross Value Added (GVA) has been reduced to 7.6 per cent as on January 2016, spelling out that the present rosy situation of inflation and the escalated growth percentages can get reversed, shortly.

Rajan expects food inflation to rise on account of weak monsoon, a further increase in oil prices and growth percentage to decline on account of corrections that can happen in the new methodology of calculating the growth index.

The growth percentage of 7.5 per cent of October-December 2014, calculated based on the new methodology was lowered to 6.6 per cent. Similar can be the fate of the latest 7.5 per cent GDP for January-March quarter since the methodology adopted is to capture the profits of 5 lakh corporates registered with the Ministry of Company Affairs.

Reversal is imminent
The reversal is imminent as most of the companies are yet to file their year-end results. Big corporates like L & T, Mahindra and Mahindra have announced 27 per cent and 39 per cent drop in Q4 net profits, which would have been surely not captured and reflected. The stern message of the governor led to carnage of Nifty 50 and Sensex by 2.34 and 2.37 per cent, respectively.

Rajan continues to be unhappy with the commercial banks which are reluctant to transmit the rate reductions by way of reduced interest rates to the corporates, small and medium enterprises (SMEs), industries, farmers and to the borrowers of housing and vehicle loans.

The governor clearly spelt out that the “banks should pass through the sequence of lending rates” to the beneficiaries by way of reduced rates which will kick start the investment cycle. He suggested infusion of capital to the banks by the government to clean up the NPAs in the loan books.

The RBI is of the firm opinion that vagaries of monsoon will play a critical role, which would build inflationary pressures on food prices. Rajan put the onus on the government to take steps to overcome food shortages, build buffer and to decide upon the type of food products to be imported and exported depending on the price advantages.

Rajan has made it explicitly clear that reduction in rate is not the panacea for growth. The success of India’s growth story takes place when the banks starts aggressively lending to the industry at reasonable rates and when the government removes the supply side constraints without of course the El Nino effect of the monsoon.

(The writer is a Bengaluru-based banker)

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