For now, feels like good times

Subir Roy
Senior Economic Analyst

After the interim Budget which had goodies for all, the government has sent another signal that it wants the electorate to feel as good as possible. The interesting part of this second signal is that it has had to follow a slightly indirect route. It comes from the Reserve Bank of India (RBI), which is an autonomous regulator and, on the face of it, the twin decisions that its monetary policy committee took on Thursday are its own. 

But the recent history is that there was a huge face-off between the then RBI Governor, Urjit Patel, and the government after which he resigned. His replacement, Shaktikanta Das, a former civil servant who oversaw the demonetisation exercise from the Finance Ministry, has a record of pursuing the government’s line with alacrity (which he must, of course, as a civil servant). So, rid of euphemism, the government now has its own man at the head of the RBI and he has delivered to order. 

The twin decisions are: cutting the policy rate by 0.25 per cent to 6.25 per cent and changing the monetary policy stance (the way it sees the future) from ‘calibrated tightening’ to ‘neutral’. What this means is that the RBI no longer expects to slowly tighten monetary policy (making money dearer) looking ahead but has an odds-even view. As for the cut in the policy rate, this is the first time that it is being done since nearly one and a half years ago. It means that the RBI will now lend money to banks against government securities at 0.25 per cent, less than what it was doing earlier.  

The ‘repo’ in the policy repo rate stands for ‘repurchase obligation’. When a Central bank issues government securities, it, in fact, borrows money from the market on behalf of the government. The repo rate is the rate at which the bank says it is obliged to repurchase those securities from the market which are offered to it, thus adding to liquidity.

A lowering of the repo rate means that money will get cheaper and the change in stance to ‘neutral’ means the market can expect another rate cut before the end of the financial year, that is before April. 

Now before the excitement that the floating rate of interest for borrowing, say housing loan, will fall slightly and have a downward impact on EMI, it is important to note that such is the mechanical process, banks will not be able to, even if they want to, pass on the rate cut immediately, that is not before April. 

Besides, bank lending is growing faster than deposit mobilisation. So, if anything, banks should want to raise their deposit rates to attract more deposits, not lower them. Additionally, private sector banks are already paying more for deposits, so the scope for public sector banks (they account for the bulk of the market) to lower their deposit rates will be limited. If deposit rates are sticky downward, can lending rates go down in any meaningful way?

Lastly, a particular bank may decide that it has a whole lot of provisioning to do for non-performing assets and so needs to earn more. It can do this by increasing the margin between its borrowing and lending rates. It will, say, cut the interest rate it pays its depositors but not the rate it charges its borrowers. So, no relief on housing loan! It is all right to remain optimistic, but don’t think of it as a done deal (interest rate cut on borrowing). The government will, however, keep nudging the public sector banks to lower lending rates.  

The RBI has given several reasons for its change of outlook. First, the global ones. One, the growth prospect of the advanced economies is looking none too good and any growth impetus has to come from within and not without. Two, emerging economies, overall, are clearly in a slowdown phase, the sentiment being created foremost by the big boy who is a youngster in name only, China. Three, commodity prices — many emerging economies live by selling them — have recovered from their immediately low level, but are not yet at the past peak. Four, global financial markets are calmer now.  

Domestically, there is a need to give a push to investment demand and also to industrial activity, which has slowed after October. There is a downward revision of inflationary projections. The Central Statistics Office (CSO) has brought down the growth projection for the current year by 200 basis points, compared to the monetary policy outlook in December. Slightly at the margin, there is a need and scope to give a gentle push to growth as inflation is not an issue.        

These are the official reasons given by the RBI for doing what it has done. What has been left unsaid is that there is pressure from the government to make money easy to come by in the run-up to the elections. 

The focus of official thinking is revealed in two other decisions announced. The RBI has eased bank lending rules for non-banking finance companies which have been shaken ever since IL&FS defaulted.  NBFCs running out of money means the tap being turned off for, among other things, affordable housing loans and money for small businesses via microfinance institutions. A big issue before Patel’s departure was the need to address the liquidity crunch facing NBFCs.

So, the outlook before the voter and businesses is that there are at least three months of good times ahead. What will happen thereafter, when a new government gets down to working out the arithmetic that is has inherited, is another matter.