Repo rate cut: untimely, unkind

The six-member Monetary Policy Committee (MPC) of the Reserve Bank of India has for the second time in three months reduced the repo rate by 25 basis points. It now stands at 6%.

The decision was 4:2 in favour of the rate cut, while the decision to maintain status quo of the policy stance at ‘neutral’ was 5:1. Chetan Ghate and Viral Acharya voted to keep the policy rate unchanged; R S Dholakia voted for ‘accommodative’ stance.

The reduction of repo rate, the rate at which banks borrow from RBI, can at best be a ‘Ugadi’ gift and a mood elevator to all the stakeholders -- government, bankers, corporates, MSMEs and retail borrowers of home loans, personal and vehicle loans. The MPC’s rationale for the reduction is to push up sagging economic growth (6.6% GDP in Q3) and subdued private investment, boost exports and provide one last chance to both public and private banks to pass on the interest rate reduction to borrowers, industries, MSMEs, especially to the growth engine sectors -- infrastructure, housing, real estate, agriculture -- in the fond hope of kickstarting the private investment cycle via the ‘multiplier effect’.

Bank credit to micro and small industries at 0.6%, medium industries at 0.7% is pathetic against the total bank credit growing at around 14%. Bankers are diffident to lend to core sectors since they are laden with humongous NPAs to the tune of Rs 12 lakh crore and resolution is not happening. Cumulatively, there has been a front-loading reduction of 50 bps (0.5%) since the last MPC meeting but the ‘rate transmission’ by banks is at a dismal 10-15 bps (0.1-0.15%) only.

Unfortunately, every critical sector in the economy is languishing and showing visible signs of stress. Growth in the eight core sectors slowed down to 2.1% in February (5.4% in February 2018), the Index of Industrial Production (IIP) grew at a meagre 1.7% in January (7.5% in January 2018), 11 million jobs were lost in 2018 as per the Centre for Monitoring Indian Economy (CMIE).

Sales of tractors, two-wheelers and cars nosedived in February, which is the litmus test of growth shoots. The worst is the pathetic performance of the overall economy as per the latest Nikkei Purchase Managers’ Index (PMI). The PMI-Manufacturing for March has dropped to the alarming low of 52.6 vis-a-vis 54.3 in February. The PMI-Services for March is at 52 as against 52.5 in February, and the composite PMI is scary at 52.7 in March as against 53.8 in February, a six-month low. A reading above 50 indicates expansion and below it indicates contraction.

Revision of GDP forecast

This gloomy scenario has compelled the Asian Development Bank to revise the GDP forecast for India to 7.2% for FY19 from 7.6%. The Central Statistical Organisation (CSO) has pegged GDP growth down to 7% from 7.2%. The fear of recession has forced the MPC to revise the growth projections for 2019-20 in the downward direction, from 7.4% to 7.2%.

The RBI governor and the MPC should have pressed the ‘pause’ button and not have ventured a successive rate cut, knowing fully well that it is the lack of rate transmission by banks and not the CPI inflation per se (which has always been under the mandated 4%) which is the critical bottleneck.

On the contrary, reduction in the rate will have an adverse effect on savings as banks will eagerly reduce deposit rates. Hence, savings will get diverted to riskier avenues and to certain institutions/NBFCs which offer high interest rates on deposits which, in turn, leads to NBFCs charging unreasonable rates on their loans. Both depositors and borrowers will be the sufferers.

To help housing finance companies, banks and NBFCs to better manage credit and liquidity risks and to facilitate funds at ‘reasonable rates’, the RBI governor has proposed a committee on developing ‘securitisation market’ for housing/mortgages. This will overcome ‘mismatch’ between short-term deposits and long-term loanable funds. Further, implementation of linking floating interest rates on retail loans and loans to MSMEs by banks to an external benchmark like repo rate, has been deferred.

The RBI should have kept in view the general elections, the huge government borrowing programme of Rs 7 lakh crore, and the worrisome steady increase in food prices (cereals and pulses) in the wholesale price index (WPI), which will seep into the CPI and cause distress. The core inflation is already stubbornly above 5%. There has already been an upturn in the February CPI inflation at 2.6%.

The situation can further aggravate with the below average monsoon/ El Niño forecast by Skymet, a spurt in crude oil prices to above $70/barrel, the fiscal deficit breaching 3.4% at Rs 8.51 lakh crore in February against the target of Rs 6.34 lakh crore.

The prudent approach would have been to wait and watch until June 2019. The untimely reduction in repo rate is the ‘unkindest’ cut for the economy, but the RBI governor gets kudos from the sections that matter.

(The writer is a Bengaluru- based banker)