In the bi-monthly monetary policy review announced on June 7, 2016, RBI governor, Raghuram Rajan has left the repo rate [interest rate at which the apex bank lends money to commercial banks] and cash reserve ratio [CRR] [funds that banks have to keep with RBI as a percentage of their deposits] unchanged at 6.5% and 4% respectively. In sync with repo rate, the reverse repo [rate at which banks lend money to RBI] remains un-altered at 6.0%.
During his press briefing, however, Rajan maintained that his so called accomodative stance [implies being receptive to borrower’s sensitivities by way of lowering lending rate and making adequate funds available] continues. That should have called for reduction in the policy rate or pumping more liquidity. Keeping things on hold cannot be taken to mean an accomodative stance.
A constellation of factors worked on his mind to ensure that he stays in the yellow light zone. These included three developments which may have prompted him to take a harsh view on interest rate. And, there was one clear positive that would have made him lenient. On the whole, he made no move at all neither towards increase nor decrease.
First, the consumer price index [CPI] – a measure of inflation to which he has anchored movements in policy rate – for the month of April, 2016 was 5.3% up from 4.83% recorded in March, 2016. Second is the impending hike in policy rate by Federal Reserve Board [FRB] USA before year end. Third is partial transmission of reduction in rate in the past [since January 2015, against a cut of 1.5% in policy rate, banks have reduced lending rate by only 0.65%].
True, these are disquieting but, they are not strong enough to push for halting the policy rate reduction trajectory. First, notwithstanding recent increase, CPI has remained consistently below 6% target for January, 2016 set by Rajan himself not to mention whole-sale price index [WPI] that remained in negative territory for almost 18 months [pertinently, it was Rajan who changed the anchor from WPI to CPI after taking charge at RBI].
The governor has also overplayed the impending increase in US interest rate by FRB. Technically though, this could lead to foreign investors moving out funds from emerging market economies [EMEs] including India. But, given our strong fundamentals and being the only bright spot in a gloomy global economy, it is naïve to believe that foreign investors would leave merely responding to US rate hike.
As regards transmission, just because banks have not done their job cannot be a good reason for apex bank not to do things that will support growth momentum. True, sustainable growth requires simultaneous action on a host of critical fronts like boosting demand, investment [especially private], building infrastructure etc. But, the role of high interest cost cannot be wished away.
At present, the lending rates continue to be in double digit and have a crippling effect especially on small and medium enterprises [SMEs] and start-ups. Pertinently, both are getting pivotal attention under Modi’s agenda for inclusive development. Under Rajan dispensation, these sectors have been at the receiving end and they need a booster dose that can come only with further slide in rates.
Clearly, the governor has given disproportionate importance to these developments and resorted to biased interpretation to suit his preference. Luckily for borrowers, he spared them the ignominy of hike in policy rate, thanks to projection of good monsoon [June – September, 2016] by the meteorological department which bodes well for increase in food production and consequent, moderation in food inflation.
The problem is not with numbers; it is primarily with governor’s mind-set couched in a conservative tone. He had amply demonstrated this during the first 16 months of his stint at Mint Street [September, 2013 to December, 2014]. During that period, he had stuck to the high policy rate despite CPI ruling well below his own benchmark of 8% for January, 2015. Then, he justified this on ‘inflationary expectations’; those were imaginary.
The apparent basis for such imagination was drought without giving much weight to good supply management unleashed by Modi – government. Rajan also erred in a reading of likely global price of crude oil which started its downward journey after reaching a peak in June, 2014. While, the economy needed growth impulse, he stuck to inflation targeting even disregarding the fact that prices had already started moderating.
Since January, 2015, the reductions in policy rate were literally forced on him with inflation remaining consistently low all through; need for putting India on a high growth trajectory being paramount and pressure building on him from all stakeholders viz., industry,trade/commerce and even government which was keen to get funds for projects unclogged via speedy approvals and clearances.
RBI should come out of its shell and make some proactive moves to demonstrate that it is a constructive partner in India’s growth story. There are some feelers that it may come up with reduction in the next bi-monthly review due in August, 2016. Then, Rajan would have seen good rainfall actually happening. A good policy is one that anticipates and drives events; certainly not one that passively reacts to them.
There is room for at least 0.5% cut in the policy rate. Concurrently, banks should be goaded to fully transmit the reduction already made. RBI’s direction to banks to switch-over pricing of loans to ‘marginal cost” approach from April, 2016 was a good step. The governor has rightly announced a review to assess the impact. The process should be taken to its logical outcome.
But, the most daunting challenge is the high level of non-performing assets [NPAs] of banks. On an asset quality review [AQR] done on directions of RBI, they have made huge provisions leading to steep decline in profits and losses in many cases. During 2015-16, all public sector banks [PSBs] reported loss of Rs 18,000 crores. This needs to be addressed on a war footing or else any relief by reducing policy rate or CRR will be ineffective.
For now, it would be interesting to watch whether Rajan continues to occupy the Mint Street post-September, 2016!