The Reserve Bank of India (RBI) credit policy announced on Thursday was on expected lines in terms of the rate cut of 25 bps. While some expected a more aggressive stance, it does appear that the route taken by the RBI just like the Fed would be 25 bps at a time. Therefore, this has not been a surprise. The stance has remained neutral which really means that until the next policy in June the MPC does not expect any significant change in monetary conditions to justify a contrary action. Interestingly, two members did not want a change in the repo rate which can be conjectured to be linked with inflation expectations. This is the crux of the policy decision.
Will inflation be higher than what the MPC has projected"2.9-3 percent in H1 and 3.5-3.8 percent in H2? This is critical because the risk factors which are always enumerated in the policy look a bit more imminent today following the forecast of a less-than-normal monsoon this year by Skymet. This being the case, it is possible that the inflation rate would be higher at 4+ percent by the end of the year. The MPC seems comfortable with the fiscal situation presently and hence all talk of expenditure not linked to economic activity like cash transfers are assumed to be neutral in terms of inflation. This also means that the impact of spending Rs 75,000 crore on goods and services as per the Budget FY20 will not really add to growth in a significant manner as was expected when it was announced!
The important question to be asked is whether this will really work or not. Lowering of the repo rate by the RBI has to get transmitted and for this to happen, deposit rates should be lowered so that the MCLR comes down. But in the last six months or so, banks are reluctant to lower deposit rates as this has led to a slowdown in the growth in funds that has led to the liquidity crisis. While banks do always ask for a rate cut to boost their lending activity, the response on deposit rates has therefore been slower. Hence, one cannot be really sure if the lending rates will come down across the board.
Also, an interesting observation has been that banks have been aggressive in the retail space and lowered the lending rates which have seen an improvement in the mortgages space. However, when it comes to manufacturing and infrastructure, they have been cautious given the risk involved as well as Asset and Liability Management (ALM) issues. Hence, even within the lending field, there is a dichotomy in lending patterns and interest rates finally charged to different customers.
This is probably a reason as to why the RBI has also scaled down its Gross Domestic Product (GDP) forecast for FY20 to 7.2 percent from 7.5 percent earlier though will be 0.2 percent higher than that of FY19 which has been placed at 7 percent by the Central Statistics Office (CSO). This also means that one can expect more rate cuts to spur the economy during the year though assuredly the decision will be data-driven.
As the credit policy has to take a decision on interest rates based on inflation perspectives, other issues become supplementary. Therefore, the liquidity issue has not really found an emphasis on the discourse directly. This is critical today because the genesis of the liquidity problem is the lower growth in deposits relative to credit which has forced the RBI to intervene through Open Market Operations (OMOs), Liquidity Adjustment Facility (LAF), and more recently the forex swap.
Now with the repo rate being lowered, there is a chance that deposits would slow down further if rates are cut which can exacerbate the liquidity problem provided credit picks up. One can surmise that the RBI would continue to use a combination of these measures to ease liquidity through the year provided the challenge surfaces. The freeing of the SLR further for reckoning the Liquidity Coverage Ratio (LCR) is another step taken by the RBI in a phased manner to enable banks to manage their liquidity well.
On the development side, two interesting points have been made which will be referred to committees. The first relates to the securitization market for mortgages. Given the rapid growth in these loans which in fact has been the leader in the last few years, a logical corollary is to bring about the development of this market so that this segment evolves. The second pertains to creating a secondary market for bank loans. This will be quite unique because it does look like that the goal is to ensure that just like how bonds can be sold in the secondary market, bank loans too can be transferred to other parties which are willing to take them on. Therefore, these two initiatives should be looked at in conjunction as they will both ease capital that can be redeployed to augment lending. Of course, there would need to be a lot of care taken to ensure that the regulatory processes are in place and that there are enough checks created in the light of the financial crisis in 2007-08 where unchecked financial engineering led to the meltdown.
The next policy would surely be eagerly awaited as it would be after a new government is in the place where priorities and approaches could be different in case it is a different party. If there is continuity, then the storyline may be expected to be the same.