A rate cut for the second consecutive time was on expected lines

With a new Governor at the helm of the Reserve Bank, it was only to be expected that the six-member Monetary Policy Committee would veer towards cutting rates for the second time in a row; under Urjit Patel, the Finance Ministry had begun to express its impatience with the MPC’s tight stance. The RBI, in its ‘Monetary Policy Report’ as well as its first statement for this financial year, has conceded that the growth situation is not looking too good. “More recent high frequency indicators point to manufacturing growth slowing down, while investment demand is subdued. Credit flows to micro and small as well as medium industries remains muted, though they somewhat improved for large industries,” the policy observes. However, the more detailed policy report intriguingly hopes for an improvement in private investment this year, even as the policy reiterates “slackening of urban and rural demand as well as investment activity.” If rates needed to be cut to spur private investment, with the government at present shouldering the burden through its roads and housing initiatives, the difficulties in adopting an accommodative stance too have been spelt out. These include a possible uptick in retail inflation, led by food prices (in the wake of gloomy monsoon forecasts) and fuel. However, it seems that the key constraint to accommodation is the prospect of interest rate arbitrage leading to capital outflows and weakening the rupee, with elections set to begin.

It is a moot point whether banks can transmit a rate cut. If the IL&FS crisis is likely to have promoted risk-averse behaviour, the uncertainty arising out of the February 2018 circular being scrapped is likely to add to it. It appears that the RBI is a bit unsettled, as its equations with the Centre are being reset. There was an unmistakable tentativeness in the manner of the RBI top brass as it fielded, or rather chose not to field, questions from the media. RBI Governor Shaktikanta Das chose not to say much on Tuesday’s Supreme Court ruling that effectively transferred the power to initiate bankruptcy proceedings from the RBI to the Centre — except for promising that a new framework would be out soon. In this situation of utter fluidity, with mutual funds and other financial entities too exposed to IL&FS, it is anyone’s guess how credit to the commercial sector can take place at lower rates and spreads.

With the RBI candidly pointing to a demand deficiency (urban demand being affected with the effect of the pay panel hikes wearing out) and export activity unlikely to pick up in a hurry in a climate of tepid world growth, the onus lies on the government to keep investment going. Fortunately, there is space on the price front to do so, with ‘crowding out’ fears being somewhat overstated. An accommodative stance may, therefore, be called for.

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