RBI ‘rate pause’ signal to govt, banks

The unanimous decision of the six-member Monetary Policy Committee (MPC) to maintain status quo on policy rates has stumped bankers, analysts and those who had predicted a cut in the repo rate by at least 25 basis points (0.25%). Repo rate - the rate at which banks borrow from RBI — is unchanged at 5.15%.

Whatever may be the rationale given by the MPC for the ‘pause’ on repo rate, the MPC and RBI Governor Shaktikanta Das, who has successfully completed an year in that office, seem to be deeply concerned with rising retail price inflation (CPI – Consumer Price Index) and plummeting economic growth. The second quarter (July-September) GDP growth nosedived to a six-year low of 4.5% (following 5% in Q1). The Gross Value Added ( GVA), excluding government spending, fell to 3.2% during July-September.

The CPI shot up to 4.62% in October 2019, the highest in 18 months and breaching the RBI’s mandated target of 4%. Food price spiked to 7.89% in October (5.11% in September).

Coupled with the visibly stagflationary trend of rising prices and muted growth, the continuous repo rate cuts (by 135 bps, or 1.35% since February 2019) not being transmitted by banks in interest rate reductions, fiscal slippage, excess rains/floods affecting crop output, spike in food prices, and growth in the eight core sectors (except fertilisers) at its worst at 5.8% in October, have all forced the MPC to adopt a “wait and watch” approach on how the various moving parts and counter-cyclical government measures unfold over the next three months.

The RBI Governor exuded confidence over ‘green shoots’ in the economy. The Nikkei India Services Purchasing Managers Index (PMI), the Manufacturing PMI and the composite output index rising to 52.7, 51.2 and 52.7 in November, respectively, seem to validate the point.

A PMI reading above 50 indicates expansion and a reading below indicates contraction. The MPC is concerned with the consistency, durability and sustainability of growth and opines that the rise in inflation is a near-term issue that would peak in January-March 2020 and then fall below 4% after September 2020.

In the above situation, the safest course for the MPC was to not take any action and announce the ‘rate pause’.

The RBI has slashed the GDP growth forecast and raised the CPI inflation target – nothing new for either the RBI or for the government. The real GDP growth target has been lowered to 5% from 6.1% for 2019-20. Growth is seen to be range-bound — 4.9-5.5% — during October 2019-March 2020. April-September 2020 GDP growth is seen at 5.9-6.3%.

The CPI inflation target for October 2019-March 2020 has been raised to 4.7-5.1% (earlier target 3.5-3.7%) and 3.8-4% for April-September 2020.

These forecasts are losing sanctity as they are revised frequently, and the MPC’s usual caveats that the targets are revised based on ‘incoming data, evolving growth-inflation dynamics’, which have become clichés.

The MPC has put the ball in two courts – the banks and the central government.

Banks have just transmitted around 40 bps (0.4%) so far by reducing their lending rates to corporates, MSMEs, housing and personal loans. But they have simultaneously slashed deposit rates by almost 50 bps (0.5%) during February-November 2019. Linking bank lending rates to the external benchmark of the repo rate since October 2019 is yielding results. The benefit/impact of monetary easing should trickle down and match the 135 bps reduction by RBI by January 2020.

Governor Das and the MPC have conveyed a subtle but clear signal to the Narendra Modi government. By maintaining status quo in policy rates, the next MPC review being on February 6, 2020, the MPC wants to watch what the government does with the Budget on February 1.

This is important because the MPC is concerned with the fiscal slippage. The fiscal deficit has already crossed 103% of the target of 3.4% of GDP.

And consider these: GST collections are down, government expenditure is mounting, payments to infrastructure projects and NREGA are pending, the hike in telecom tariffs will have an inflationary effect, even as legal, labour and land reforms are pending, as do issues regarding the IBC Act and the governance of urban co-operative banks (post-PMC Bank fiasco), guidelines on the utilisation of the Rs 25,000-crore Alternate Investment Fund for resolution of stalled real estate projects, overcoming National Housing Bank’s insistence that housing finance companies give exclusive charge of their assets under management (AUM) to NHB, which other lenders/banks will not agree to.

The RBI seems to feel that the onus of economic revival now rests with the central government, and consists in resolving the above bottlenecks on an urgent basis without resorting to band-aid solutions.

The RBI will closely monitor the transmission of rate reduction by the banks, credit flows to industries, infrastructure and housing, as there is no dearth of liquidity in the system. If both banks and the government discharge their responsibilities diligently, on fast track and with political will, the RBI Governor has reiterated that the window for rate cuts by another 50 bps is open till March 2020.

(The writer is a former banker)