In the last bi-monthly Monetary Policy Committee’s (MPC) review announced by its Governor Shaktikanta Das on August 6, the Reserve Bank of India (RBI) had kept the policy repo rate unchanged at four per cent. It had also kept the reverse repo rate or the interest rate the banks get on their surplus funds parked with the RBI unchanged at 3.35 per cent. It continued with the “accommodative” stance of the monetary policy as long as necessary to revive growth and mitigate the impact of Covid-19, while ensuring that inflation remains within the target.
In the build-up to the next bi-monthly review (originally scheduled for October 1, which was postponed to October 9, due to the delay in appointment of three external members of the MPC), there was an expectation that there wouldn’t be any changes this time round. Things have happened on expected lines even as the RBI has maintained status quo on key policy rates.
There are four major reasons as to why any further action in gliding the policy rate on the downward trajectory — as demanded by a certain section of the industry — was totally unnecessary.
First, ever since the incumbent Governor took charge (December 2018), the RBI has handed out a cumulative reduction in repo rate of 2.5 per cent. Of this, during 2019, a total cut of 1.35 per cent was delivered in five instalments, the last one being under the policy review announced on October 4, 2019. This brought down the rate from 6.5 per cent in the beginning of the year to 5.15 per cent on its close. The apex bank also tried to boost the economy by pumping liquidity using policy instruments such as Open Market Operations (OMOs).
The above policy moves were made in the backdrop of the slide in the real Gross Domestic Product (GDP) growth that had commenced in the third quarter of the financial year (FY) 2018-19 and continued all through FY 2019-20, the intent being to not just contain the slide but also to revive it. Yet, the deceleration continued with growth plunging to a little over three per cent during the last quarter of FY 2019-20 and the yearly figure settling at a low of 4.2 per cent. But that did not deter Das from continuing with a cut in the policy rate.
On March 27, he reduced the policy rate by 0.75 per cent. This was followed by a further cut of 0.4 per cent on May 22, thus delivering a total reduction of 1.15 per cent post-pandemic. Das also announced on March 27 and April 17 measures like reduction in the cash reserve ratio (CRR), auction of Targeted Long-Term Repo Operations (TLTRO), hike in accommodation under the Marginal Standing Facility (MSF) and so on, to inject total liquidity close to Rs 5,00,000 crore.
Despite these measures, growth during the first quarter of the current FY plunged to minus 24 per cent. During the second quarter ending September 30, though the situation was not as bad, the growth was still lower than during the corresponding quarter of 2019 (for the whole of the current year, Das has projected a decline of 9.5 per cent — that, too, is predicated on positive growth during the last quarter). These trends clearly show that neither reduction in policy rate, nor pumping liquidity in the system are working.
Second, according to Das, of the 1.35 per cent reduction in the policy rate during the pre-Covid phase, only about 0.6 per cent was transmitted by banks by way of corresponding reduction in the lending rate. If transmission is not even 50 per cent then, why keep harping on a cut in the policy rate. Are we to infer that banks are pocketing the differential? The truth is, we are trying to see a strong correlation which either does not exist or is very feeble, if at all there is one. A bank fixes the interest rate it charges from borrowers based on the interest rate it pays on deposits, plus cost of its intermediation. It has also to factor in the cost of non-performing assets (NPAs) or loans which can’t be recovered. Even as the policy rate is posited as an external benchmark for determining lending rate, the latter can’t exactly follow the movement in the former. A perfect correlation would have been possible if only the RBI was its sole source of funding; but that is theoretical, to say the least. Third, despite the RBI opening several taps and banks flushed with funds for onward lending (this was done during FY 2019-20 and on a much larger scale during the current year), the latter have not stepped up lending. During 2019-20, bank credit grew by 6.1 per cent, less than half of the 13.4 per cent growth registered during 2018-19. The trend has got aggravated during the current year. Overall non-food credit off-take from the banking system declined by Rs 1,40,000 crore to over Rs 90 lakh crore during April-July, 2020.
On April 17, while announcing reduction in the reverse repo rate from the existing four per cent to 3.75 per cent, Das had argued it would goad banks to lend to businesses instead of parking excess funds with itself (they were then holding a gargantuan Rs 6,90,000 crore with the RBI). The rate has since been further lowered to 3.35 per cent to ensure that banks don’t keep the money with the apex bank; instead lend. Yet, the excess funds parked by them have crossed Rs 8,00,000 crore. Apart from the disruption caused by the contagion and the resultant compression in demand for credit, sanctions and disbursements have also been impacted by the banks’ increasing risk-aversion and conservative approach to lending.
Fourth, the initial uninterrupted spell of lockdown for three months and even thereafter, intermittent lockdowns at the State/local level, have exterminated demand on a scale never seen before. Apart from lakhs of businesses downing shutters, millions losing jobs or facing cut in wages and salaries, even those who survived the Covid onslaught and had surpluses, could not spend (due to the sheer compulsion of “social distancing”, forcing prolonged closure of a vast swathe of businesses especially in the service sector, like restaurants, cinema halls, multiplexes, tourist destinations and so on).
The gravity of incapacitation engineered by the pandemic can be gauged from the fact that currently, cash with the public is at a historic high of about Rs 26,00,000 crore or 15 per cent of the GDP (assuming 10 per cent contraction in nominal terms during FY 2020-21) — up from the Rs 17,00,000 crore it was at the time of demonetisation in November, 2016.
A major factor that has a profound impact on demand has a lot to do with scams galore. These involve siphoning off funds from banks, non-banking finance companies (NBFCs) or even directly from the public (say by builders) and so on. Running into hundreds of thousands of crores, these add to the personal wealth of a select few, which is either stashed abroad or kept within India as “undisclosed income” (black money). Had this money remained with millions to whom it actually belongs, this would have added hugely to the purchasing power, reduced the NPAs of Banks/NBFCs and increased their ability to lend more.
Unlike the pall of gloom surrounding the August meeting of the MPC, this time the RBI exudes confidence even as the Governor sees the “Indian economy entering into a decisive phase, seeing easing of contraction in various sectors. Deep contractions of Q1 are behind us and silver linings are visible in easing caseloads across India.” He also sees retail inflation to be moderating from the third quarter onward, driven by a bright agriculture outlook and oil prices remaining range-bound. The Governor has also promised measures as necessary “to assure market participants of access to liquidity and easy finance conditions” (Rs 20,000 crore-OMO auction next week and On-tap TLTROs of Rs 1,00,000 crore to be made available till March 2021 — linked to the repo rate — are some of the steps in this direction).
These are add-ons to the existing pool of measures in the same category. Just as those measures failed to deliver, it is unlikely that these incrementals will do any better. It is good that the RBI has kept the key policy rates like repo and reverse repo rates unchanged or else in the current scenario, when the economy is besieged with structural constraints, any further cut thereof would have been rendered infructuous. A holistic approach is needed to address the structural constraints of the economy. This should encompass policy reforms to lift business sentiment and boost investment; tackle NPAs on a war footing; goad banks into proactively taking up project lending; and result in stern measures to deal with scams with greater emphasis on prevention. Sans these, any stimulus won’t be of much use in lifting the economy.
(The writer is a New Delhi-based policy analyst)