Beyond the policy rate cut

With inflation staying below 3 per cent, economic indicators telegraphing both a consumption and investment slowdown and global central banks rethinking tight monetary policies, it was a foregone conclusion that India’s Monetary Policy Committee would vote to effect a third consecutive cut in policy rates in its review this week. What came as a pleasant surprise though was the MPC’s realistic growth forecasts and recognition of the fact that the economy is in need of some serious resuscitative measures. This is the first policy review since this slowdown began, when the MPC members have voted unanimously for a rate cut and adopted an accommodative stance, while pledging to “accommodate growth concerns by supporting efforts to boost aggregate demand and reinvigorate private investment activity.”

However, if the MPC’s recognition of the ongoing slowdown is a welcome development, the RBI’s sanguine stance on the brewing NBFC crisis is perhaps a cause for worry. While market participants were primed for the announcement of a liquidity lifeline to NBFCs, the RBI’s statement on developmental and regulatory policies makes no mention of the NBFC crisis. Specifically asked about whether there were any plans to open liquidity taps to the sector after the delay in repayments by DHFL this week, the Governor responded that the RBI was not the regulator for housing finance companies and indicated that such interventions would be forthcoming only if there was a threat to systemic stability. These statements gave the impression that the RBI is happy to let individual NBFCs, however large, sink or swim on their own merits and would deal with the consequences of any entity-level failure if and when they posed a contagion risk to the entire market. One hopes that the RBI does have a contingency plan in mind to deal with such an eventuality, as contagion seems almost inevitable in the event of the struggling NBFC going down. Given the illiquid nature of India’s corporate bond market and the total absence of a market for lower rated paper, a default by a large NBFC (on top of the recent IL&FS debacle) can trigger redemption pressure and force a selling spree by debt mutual funds who manage over ₹11-lakh crore in assets. It could also freeze lending to all non-AAA borrowers and shake up public confidence in deposit-taking entities. This also makes it quite urgent for the RBI to nudge its new working group on the liquidity management framework to devise a liquidity mechanism for corporate bonds.

It also remains doubtful if banks will choose to transmit this latest round of rate cuts to their retail and smaller ticket borrowers, given that they have been quite tardy in doing this after the last two rate cuts. The RBI seems to have exhausted all the tools in its armoury to ensure transmission. Therefore, the ball is now in the Centre’s court to revisit its small savings rates, so that banks get a leg up on their deposit flows.

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