Monetary policy, a lost opportunity

With macro -economic indicators showing positive signals, RBI missed an opportunity to slash policy rates

The other quantitative credit controls - cash reserve ratio (CR)  at 4 per cent ( share of deposits which banks must park with the RBI, which does not earn  any interest) , statutory liquidity ratio at 21.5 per cent (reserve requirement that the banks required to maintain in the form of gold, government approved securities/bonds) are untouched by the RBI. Reduction in these rates, though not the panacea for immediate results, would have surely provided additional liquidity, positive signals and a morale booster to the economy which is showing good signs of recovery.

The RBI’s rationale for keeping the rates untouched is the uncertainties in the monsoon, spiralling of the core inflation, non-transmission of the benefits of the earlier rate reduction by the banks and the cascading effects of the increase in service tax which has come into effect from June. The consumer price index (CPI) based inflation in June, has risen to 5.4 per cent.

 The governor seems to have lost a good opportunity of slashing the policy rates just when the macro economic indicators have shown positive signals requiring the big push from the RBI. Reduction in the repo rate by 25 -50 bps would have bolstered the growth  with the support of the plummeting crude oil prices at $ 48.93 per barrel, healthy GDP  growth (2014-15 - provisional) of 10.5 per cent at current prices, comfortable fiscal deficit at Rs 2.86 trillion / 51.6 per cent of this year’s budget, good tax revenue collections in the current year of over Rs 1 trillion, substantial forex reserves at $ 353.64 billion and increased net investment by the foreign institutional investors (FIIs)  at $ 900 million in July.

By merely targeting the CPI and keeping a hawk’s eye on inflation, the governor has ignored the bigger picture and role of the RBI as a catalytic agent of growth and development.

 The monetary transmission of the earlier reductions in rates by the RBI to the extent of 75 bps, though slow, is gradually getting percolated and being passed on by the banks to the borrowers. Banks have passed on rate benefit to the extent of 25-50 bps after recalibrating their fixed deposit rates.

Banks would have further cut the lending rates, but for their poor April-June Q1 results on account of elevated levels of non performing assets (NPAs). This critical issue has been addressed by the government, by announcing Rs 70,000 crore capital infusion. This will help the banks clean their balance sheets, transfer stressed assets to the asset recovery cells (ARC) and lend with cautious aggression on fast track basis.

Even the rates of commercial paper (CP) and certificate of deposit (CD) have declined by almost 75 -100 bps, thus facilitating access to cheaper funds by corporates and industries with sound health.

The reduction in bank rates, interestingly, will also help housing finance companies, micro finance institutions and NBFCs get cheaper funds from the commercial banks, National Housing Bank etc for their onward lending to borrowers, in the range of 9.5 - 12 per cent.  Lag effect of transmission is showing positive results, though, in snail pace.

Passing on benefits

Further reduction in rate by the RBI at this  opportune time in August being the crucial second quarter of the financial year, would have straightaway helped the bankers, financial institutions, housing finance companies and the NBFCs to continue to pass on the benefits of the rate cut to their borrowers.

The timing would have been great since there will be an uptick in the credit off-take from August onwards after the end of the inauspicious “Aashada” - double whammy of two months ending August 15, followed by long festive season, benefiting both the producers and the consumers.

This window of opportunity has been missed by the RBI. The governor’s indication that he is open for rate cuts at a later date may not help the sagging investment cycle to revive, as his priorities would shift in assessing the geopolitical effects of the proposed rate hike by the US federal reserve when there will be flight of capital from India to better pastures.

Even the fear of uncertain monsoons as one of the reasons for holding the rate cut by the RBI seems to be misplaced.

 The rainfall has been normal in June and July. The Met office has confirmed that the rainfall would only be 12 per cent deficient with no el nino effect.

Rajan’s (economist from the prestigious MIT) obsession with monsoons, inflation and transmission coupled with the misery of the government which is stuck in getting the crucial GST, land acquisition bills passed and aiming at removing the supply side bottlenecks, is a recipe for the economy not to gallop.

(The writer is a Bengaluru-based banker)