Holding rates, RBI sends tough message

Holding rates, RBI sends tough message

The Reserve Bank of India's 6-member Monetary Policy Committee (MPC) acted on expected lines last week, but with a very hawkish tone, in maintaining status quo on the key policy rates. The decision was 5:1, with Michael Patra strongly recommending a 0.25% rate hike, which signals what is in store by April 2018.

The MPC is seriously concerned with the risks of an upward inflation trajectory – Consumer Price Index (CPI) inflation, which has been on the rise continuously, from 3.58% in October to an alarming 5.21% in December, the culprits behind the spike being rise in crude oil and food prices.

What is alarming is the MPC's downward revision of the Gross Value Added (GVA) for FY18 to 6.6% from 6.7%, which would correspond to around 6.8% GDP, coupled with an increase in the inflation projection to 5.1% for Q4 FY18 (January–March 2018) from its own glide path  range commitment of 4.3–4.7%. Even the inflation target for April–September FY19 has been revised upwards in the range 5.5-5.6% and tapering down to 4.5% during October-March 2019, which would signal stabilisation of the economy and seamless operation of GST and other policy initiatives.

The rationale for shifting the goalposts is the MPC's concern over certain budgetary proposals of the central government and other imminent risks in the short and medium term which will trigger "cost push inflation" – inflation due to rising cost of inputs such as labour and raw materials.    

The MPC is seriously worried about the impact of the increase in the minimum support price (MSP) to 150% of the production cost on kharif crops, custom duty hike, slippage in the fiscal deficit target – rising to 3.5% of GDP vis-à-vis the 3.2% target. Moreover, there is no clarity on the modalities and methodology of raising funds for various populist schemes announced in the central budget such as MSP, the proposed National Health Protection Scheme, Rs 2.1 lakh crore for banks recapitalisation, Rs 6 lakh crore on infrastructure and farm sector reforms.

The House Rent Allowance component of the 7th Pay Commission largesse, the cumulative deficit slippages of state governments on account of farm loan waivers, uncertainty in the 'quantum flows' of GST receipts which will impact the government's borrowing programmes, and consequently on the borrowing cost/bond yields (heated at 7.55%), have all contributed to the MPC deciding to maintain status quo on the policy rates, with the stern message that 'all is not well' with the economy. It warrants great vigilance and fiscal prudence. Not tinkering with the rates is also a way to nurture the 'nascent recoveries' and to push bank credit, which has for the first time touched double digits – at 10% - after a long gap.

The global uncertainties over crude oil price, which could touch $75 per barrel shortly, spurt in commodity prices, rate hike by US Federal Reserve, and geopolitical upheavals have weighed heavily on the MPC.

The repo rate – the rate at which banks borrow from RBI – is unchanged at 6%. So are the reverse repo-rate at 5.75% and the cash reserve ratio - the share of deposits which banks must park with RBI without earning any interest - at 4%. The statutory liquidity ratio (SLR) - the reserves banks are required to maintain in the form of gold or government-approved securities - is unchanged at 19.5%.  Surprisingly, the MPC did not touch upon the unabated increase in bond yields, which has hit 7.55%, which has created not only high volatility in the market, chaos in the equity market, but also cancellation of numerous bond issues of the RBI or the government. Maybe the RBI has left this for the market forces to bleed and settle the issue, as  we are witnessing in the Sensex carnage during the last three days, coupled with the pulling out of money by foreign institutional investors, thus impacting the rupee to dollar pricing also.  

The MPC has granted two 'gifts' to the MSME sector. The first is the recognition of non-performing assets (NPA) at 180 days overdue (instead of at 90 days) with the lending banks, of course with a rider. The MSMEs have to be GST-registered, have standard accounts (no dues)  with the lenders as on August 31, 2017, should have accumulated overdues from September 1, 2017 to January 31, 2018, with a cap on the aggregate lending exposure of Rs 25 crore per MSME. This forbearance has been granted as MSMEs were seriously affected during GST implementation, which had resulted in their becoming defaulters. This can have a ripple effect.

The second is a more welcome and durable policy announcement. The upper cap for MSME lending of Rs 10 crore by the banks has been scrapped. This will facilitate higher lending at reduced interest rates to the credit-starved MSMEs. The Ombudsman scheme for deposit-accepting non-banking financial companies by the end of the month and harmonising banks' 'base rates' to be linked to the MCLR (marginal cost of funds-based lending rate) are good policy decisions.

(The writer is Bengaluru-based banker)