The Reserve Bank of India's (RBI) credit policy will always continue to surprise because while we expect logically a certain action based on the economic conditions visible to us, the Monetary Policy Committee (MPC) call can be different when conditions do not change. This is what makes monetary policy exciting.
Let us go back to December when inflation came down and one expected a rate cut. The MPC voted in favour of no change in rate and calibrated tightening stance even though the risks to inflation existed. Now, the risks have not changed and food prices can go up as can those of oil. While it says that HRA is no longer pressurising inflation, health and education is. More money with people due to the fiscal stance taken on cash transfers will put pressure on prices. But this time not only has the RBI gone in for a change of stance but also lowered rates by 25 bps. Four of the 6 members have voted for this decision against all the 6 who voted for no change last time.
The view on inflation remains virtually the same except the language. It will not cross 4 percent for sure next year and for the second half will be 3.9 percent and 3.2-3.4 percent during H1. Therefore, the risks are not really going to distort the inflation numbers significantly to cause a change in stance. But the MPC is concerned about growth which will be 7.4 percent next year over 7.2 percent (CSO estimate) this year.
The fact that it has put growth at 7.4 percent for FY19 is a bit distressing as it means that there will be no major pick-up in growth this year which is what the Finance ministry has also said in the Budget.
With GDP growth virtually remaining unchanged, it looks like that the rate cut has been invoked to push growth through investment though overtly CPI is the only target. Are we then saying that the RBI will now look at both growth and inflation unlike in the past where the argument given was that the MPC had to target inflation only? This will be interesting to follow.
How will this cut in repo rate work? The immediate impact is on the market where GSec yields will moderate further as this is the most sensitive segment. This is good news for the banks when they have to value their investment portfolio in March. The rate will, however, still be driven by demand-supply and liquidity considerations and how the RBI balances the same. But from the point of view of the RBI, a rate cut does theoretically have an assuaging effect on rates and to this extent has accomplished a task.
Deposit rates movement will be interesting to track. Today we have a situation where growth in deposits is slower than that of credit. This is one reason why the liquidity shortage issue has surfaced that has prompted the RBI to successively induce liquidity through open market operations (OMOs). Under these conditions, will banks lower deposit rates and risk funds moving away to other savings avenues like equity, mutual funds and small savings? It is more likely that deposit rates in some buckets will come down depending on the funding requirement of banks and hence will be selective in lowering rates.
Lending rates are determined by the Marginal Cost of Funds-based Lending Rate (MCLR) which is formula-driven. If deposit rates come down, then it is likely that the lending rates could decrease. Here again, it is going to be selective. While MCLR may come down less than proportionately, the benefit may not percolate to all loans and it is more likely that then retail loans would benefit the most.
Corporate loans may still be priced at the prevalent rates and would also have to counter the legacy issue of NPAs which will come in the way of banks taking their calls on interest rates. Therefore, this single cut in rates may not have a perceptible impact on growth and could at best support credit to the retail segment by lowering the cost. Considering that the Budget has also given certain benefits to the housing sector, any lowering of rates will have a positive impact.
Will this be a precursor to further rate cuts in future? The answer logically has to be yes because if all the underlying conditions which led to this rate cut are not going to change for the rest of the year, then interest rates have to be reduced further. Hence there can be 25-50 bps cut in rates in FY20 provided these conditions hold.
The MPC document is, however, quite guarded in terms of stating the risks to growth and inflation which though unchanged from the past sound a rather grim note. But given the change in regime at the RBI this could be an era of more accommodative policies if the underlying conditions are met. This seems to be the main takeaway from the policy.
(The author is Chief Economist, Care Ratings)