Not making the cut

The Monetary Policy Committee has finally cut the overnight lending rate, or repo rate, but half-heartedly. It remains committed to a “neutral stance”, meaning that it is not likely to cut rates any more this fiscal as it expects inflation to rear its head all over again (to 3.5-4.5 per cent) in the second half. As in its June 7 meeting, the MPC has failed to provide a convincing reason as to why it could not cut rates by 50 basis points to allow banks more room to reduce their rates as well. The 25-basis point cut is a concession to good monsoon coverage so far. Had the MPC been bolder, it would have created the psychological climate for banks to push the envelope on the lending front. Servicing of stressed loans could have eased, helping the ‘twin balance sheets’ of banks and the corporates.

It is also moot that with banks out of their post-demonetisation liquidity surplus phase, the repo window may be used more actively in the days to come — unless the existing inflows into the capital market once again swell up banks’ kitty. All the more reason then for the MPC to have acted more decisively this time. As things stand, the chances are that the banks, now dealing with a creeping rise in the marginal cost of funds, will use the lower repo rate to plug this gap, rather than pass this 25-basis point cut to the borrowers. In addition, some banks may pick up the cue laid down by State Bank of India and merely lower their deposit rates to cushion their finances. For the increasingly risk-averse banks (bank credit is trending at decadal lows), the challenge is to lend without burning their fingers. This explains their preference for the small-ticket retail segment. While the RBI along with the banks are proactively proceeding against large debtors, the question of reviving investment remains untackled. With capacity utilisation stuck at 72-73 per cent, despite favourable commodity prices and a good monsoon, the NPA issue should be cleared up soon while macro conditions remain favourable.

The MPC’s reluctance to cut rates has been attributed to its inflation-targeting mandate. There can be no more compelling set of circumstances to cut rates to spur growth. The decline in inflation appears structural, with headline inflation trending down, core retail inflation at below 4 per cent and food items inflation at minus 2 per cent. Growth momentum, on the other hand, is faltering. The Nikkei India Manufacturing PMI touched its lowest mark since February 2009 in July. The MPC seems to be caught in the old trap of obsessing over inflation to the point of ignoring near-deflationary conditions. It may have been persuaded to play safe with respect to the rupee value, even as the rupee is rising on portfolio flows. Fears that a deep cut may trigger a run on the currency as in mid-2013 seem far-fetched.

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