Policy rate: rude shock by RBI

The Reserve Bank of India’s (RBI) six-member Monetary Policy Committee (MPC) has given a rude shock by maintaining status quo on the policy rates. The decision was 5:1 with Chetan Ghate strongly recommending for an increase in the repo rate by 25 bps while Ravindra Dholakia recommending for maintaining “neutral stance”.

The MPC seems to be obsessed with the mandate of “inflation targeting” as legislated — to ensure inflation at 4% (+/-2%). However, the MPC has revised the stance of the policy from “neutral” to “calibrated tightening”. The MPC has surprised most by not rising the repo rate by at least 25 bps which was factored by the “money market” and by the bankers/financial institutions/NBFCs/HFCs.

Most of the bankers/HFCs have already revised their interest rates on housing loans, personal and vehicle loans with effect from October 1 itself pre-empting hike in rates by the MPC. Borrowers will be the sufferers as the same cannot be reversed now.

More shocking is the RBI’s apathy towards the 3Cs — currency, crude oil and credit which have created mayhem in the stock market/economy. Rupee, immediately after the announcement of the monetary policy breached Rs 74 per dollar for the first time and the price of crude oil surged four-year high at $86 per barrel.

This will act as double whammy in widening the current account deficit (CAD) which can breach $85 billion in this fiscal and will impact fiscal deficit too. Achieving fiscal deficit target of 3.3% of GDP will not be possible especially in the election year.

Fall out of the policy announcement, Sensex tanked 607 points to as low as 34,562 and the Nifty nosedived by 203 points to 10,396. The foreign portfolio investors have ensured flight of capital to the tune of almost $15 billion in recent months and they are fair weather friends. The credit off take and liquidity will take a serious beating since most of the banks/HFCs have already increased their lending and deposit rates with effect from October and by making borrowing costly to industries, builders, real estate, MSMEs, NBFCs.

Lending has been anaemic to core sectors like infrastructure, steel, cement, coal, roads and to the pet programme of the prime minister - affordable housing- which are the engines of growth having multiplier effects on employment, income, investment and savings. None of these issues have been addressed in the policy nor linkages established.

With bankers’ reluctance to lend with their humongous non-performing assets (NPAs) to the tune of Rs 12 lakh crore, inadequate capital coupled with fear psychosis from the recent frauds/mishappenings that have been unearthed, good corporates not interested to borrow at high costs and NBFCs facing virtual shake out, casualty will be the “economic growth” which had started showing signs of nascent green shoots.

The Nikkei India Composite Purchasing Managers’ output index (PMI) has dipped to 51.6 in September from 51.90 in August. Same with Services PMI which is four month low at 50.90 in September from 51.50 in August. This validates lack of demand and supply disruptions. A reading of below 50 signifies growth contraction.

The MPC has surprisingly lowered the retail inflation projection for the second half of the current fiscal to 3.9-4.5% citing benign pattern in food prices and further reduced the Consumer Price Index (CPI) inflation forecast for the second quarter for financial year 2019 to 4% from 4.6% and to 3.9-4.5% from 4.8% for the second half of the year 2018-19.

Revising the inflation forecast to rosy levels without giving serious thought to the damage that the spiralling crude oil price at $86 per barrel (can touch $100 per barrel) can do on the core inflation-especially on account of the cascading effects of increased fuel prices on food and transport costs, leading to spurt in core inflation.

Ground reality

This dichotomy in the stance and “fixation” on inflation targeting mandate ignoring the ground reality is intriguing. The MPC itself in its policy analysis has admitted that “should there be a fiscal slippage at the centre and/or state levels, it will have a bearing on the inflation....heightening market volatility”. The straight-jacket approach by the RBI will not work in the market dynamics/crisis which our economy is facing especially on the crude oil front, increase in interest rates by the US Federal Reserve trade wars/economic sanctions, geo political tensions.

The repo rate — the rate at which banks borrow from RBI is kept unchanged at 6.5. So, are the other policy rates — reverse repo rate — the rate at which RBI borrows from bank at 6.25%. The cash reserve ratio (CRR) — share of deposits which banks must park with RBI without earning any interest — remains unchanged at 4% and the statutory liquidity ratio (SLR) — the “reserves” banks are required to maintain in the form of gold or government approved securities / bonds — remains at 19.5%.

However, the MPC’s stance of “calibrated tightening” rules out any reduction in the interest rate in near future and provides for either status quo or increase in the policy rates which looks imminent by the year end.

(The writer is a Bengaluru-based banker)