Friday's cut in the repo rate of 25 basis points, taking it to 5.15%, which is the lowest in nine years, is unlikely to move the needle on the demand for loans by either companies or individuals. To be sure, banks will drop their loan rates since many have pegged these to the repo. However, it is not high interest rates that are keeping borrowers away; it is the sharply slowing economy-acknowledged by Reserve Bank of India (RBI) in its drastic cut in the GDP forecast for 2019-20 to 6.1%-and the fear of job losses and stagnant incomes. There are those who believe that a 40-basis-point cut in the repo would have prompted banks to lower loan rates meaningfully and stimulate demand. That, again, seems unlikely. The fact is banks are understandably cautious about lending to companies whose balance sheets are weak; not a day passes without the ratings agencies downgrading one company or another. There is little demand from A-grade companies given how working capital cycles have tightened, and how there is no rush, whatsoever, to add fresh capacity. This is borne out by the fact that although liquidity in the banking system has been in abundant surplus for more than three months now-around Rs 2 lakh crore-and loan rates have come off by about 30-35 basis points, non-food credit growth has fallen to sub-10% and is running at two-year lows. So, while Governor Shaktikanta Das has promised to stay accommodative till growth revives, and he is likely to keep his promise since inflation is expected to stay benign and well within the MPC's target of 4%, it can help only at the margin.
Indeed, the accommodative stance appears to be aimed at addressing the elevated term-premium. As bond experts have been pointing out, the term-premium remains high primarily because of concerns that the fiscal deficit will slip, owing to a shortfall in tax collections; the recent shortfall in GST collections has exacerbated these concerns. On Friday, the yield on the benchmark jumped 8 basis points to close at 6.689%. With the government failing to reduce the interest rates on small savings schemes, the term-premium could remain elevated for some more time. Also, even though there isn't much borrowing taking place, borrowing rates appear to be stuck at high levels. Additionally, credit spreads have actually been widening. Economists point out that not only is the the term-premium too high, the real repo rate is also very high despite Friday's cut. While the Governor has made it clear that OMOs will be used to add liquidity, the sharply lower GDP forecast is a sign RBI will bat for growth. By highlighting the widening output gap, the MPC is signalling to the bond markets that the rate cut cycle hasn't ended, but the promise of another cut-or even two in the next few months-doesn't seem to have eased its concerns. The other factor that is keeping credit spreads high is, of course, the stress in the NBFC sector, and also in some banks. While access to affordable credit is necessary for an economic recovery, a sustained uptick would require the government to usher in serious structural reforms including easier land and labour laws, friendly and reliable regulations, and so on.