In the last bi-monthly monetary policy review announced by the Governor, Shaktikanta Das on August 6, 2020, the Reserve Bank of India (RBI) had kept the policy repo rate — the interest rate charged by the RBI on loans it gives to banks — unchanged at 4%. 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%. It also 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, 2020, this was postponed to October 9 due to delay in appointment of three external members of the Monetary Policy Committee), there was an expectation that there won’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 4 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%. Of this, during 2019, a total cut of 1.35% was delivered in five installments the last one being under the policy review announced on October 4, 2019. This brought down the rate from 6.5% in the beginning of the year to 5.15% 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 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 revive it. Yet, the deceleration continued with growth plunging to a little over 3% during the last quarter of FY 2019-20 and yearly figure settling at a low of 4.2%. But, that did not deter Das from continuing with cut in policy rate.
On March 27, 2020, he reduced the policy rate by 0.75%. This was followed by a further cut of 0.4% on May 22, 2020 thus delivering a total reduction of 1.15% post – pandemic. Das also announced on March 27 & April 17 measures viz. reduction in cash reserve ratio (CRR), auction of targeted long-term repo operations (TLTRO), hike in accommodation under Marginal Standing Facility (MSF) etc to inject total liquidity close to Rs 500,000 crore.
Despite these measures, growth during the first quarter of current FY plunged to minus 24%. During the second quarter ending September 30, 2020, though the situation may not be as bad, the growth will still be lower than during the corresponding quarter of 2019 (for the whole of current year, Das has projected a decline of 9.5% – 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% reduction in policy rate during the pre – Covid phase, only about 0.6% was transmitted by banks by way of corresponding reduction in the lending rate. If, transmission is not even 50% then, why keep harping on cut in 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 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 but the latter can’t exactly follow 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% less than half of the 13.4% 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 140,000 crore to over Rs 90 lakh crore during the April – July, 2020.
On April 17, 2020, while announcing reduction in the reverse repo rate from the existing 4% then to 3.75%, Das had argued, this was meant to 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 RBI). The rate has since been further lowered to 3.35% to ensure that banks don’t keep the money with apex bank; instead lend. Yet, the excess funds parked by them have crossed Rs 800,000 crore.
Apart from the disruption caused by Corona – Pandemics and resultant compression in demand for credit, sanctions and disbursements have also been impacted by banks’ increasing risk-aversion and conservative approach to lending.
Fourth, the initial un-interrupted spell of lockdown for three months and even thereafter, intermittent lockdowns at state/local level has 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 viz. restaurants, cinema halls, multi-lexes, tourist destinations etc).
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 2600,000 crore or 15% of GDP (assuming 10% contraction in nominal terms during FY 2020-21) – up from Rs 1700,000 crore it was at the time of demonetization 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-bank finance companies (NBFCs) or even directly from the public (say by builders) etc. Running into hundreds of thousand crore, these add to the personal wealth of a select few which is either stashed abroad or kept within India as ‘undisclosed income’ (call it 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, 2020 meeting of MPC, this time, the RBI exudes confidence even as it sees “Indian economy entering into decisive phase, seeing easing of contraction in various sectors. Deep contractions of Q1 are behind us & silver linings visible in easing caseloads across India”, as the governor put it. He also sees retail inflation to be moderating from third quarter onward – driven by 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 TLTRO of Rs 100,000 crore to be made available till March 2021 – linked to repo rate – are some of the steps in this direction).
These are add–ons to the existing pool of measures in the same category. (read: ‘accommodative stance’). Just as those measures failed to deliver, it is unlikely that these incremental will do any better. It is good that the RBI has kept the key policy rates viz. 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. This should encompass (i) policy reforms to lift business sentiment and boost investment; (ii) tackling NPAs on war footing; (iii) goading banks to proactively take up project lending; (iv) stern measures to deal with scams with greater emphasis on prevention. San these, any stimulus won’t be of much use in lifting the economy.