Staying its hand

Given his proclivity for surprising the markets, the RBI governor’s decision to trim the repo rate by 25 basis points in his latest monetary policy review is both welcome and a surprise. Though there was widespread clamour for rate cuts, the recent rebound in crude oil prices, the bout of global bond volatility and the poor monsoon forecast had created some doubts about whether the RBI would oblige. While bond markets have taken the move in their stride, stock markets and rate-sensitive stocks in particular, have reacted badly to the review. The RBI’s cautionary tone on inflation and its statement that rate cuts were being ‘front-loaded’ are being read as signs that, having done its bit to please the crowd, the bank will opt for a prolonged status quo on rates. But this may be an over-interpretation of the review; after all, the RBI has made it clear that its rate actions will remain ‘data-contingent’. Given that very few of the events that have had the bond markets in a tizzy — the oil price spike, deferment of the US rate hike or the late onset of the monsoon — could have been predicted, the RBI has no choice but to remain flexible on the medium-term direction of its policy rates.

The RBI has once again exhorted banks to hurry up with their transmission of lower policy rates to borrowers. After dragging their feet until March, more banks have trimmed base rates. But the transmission of the 75 basis point reduction in policy rates remains incomplete. Though the RBI is of the view that market pressures will soon force banks to slash their lending rates (bond yields in the market are now lower than bank lending rates), recent trends in bank performance and credit offtake suggest that this isn’t a given. With restructured assets now accounted for in bank books, the asset quality problem seems to be getting worse instead of better. With credit growth tepid at 10 per cent, banks are also unable to expand their way out of the problem. With profits under pressure and capital in short supply, public sector banks may well choose to retain their high lending rates and protect their margins, rather than try too hard to woo new borrowers.

Will another rate cut of say 25 or 50 basis points be enough to kick-start the private capex cycle? It’s hard to say but the bulk of corporate India’s problems today has to do with over-capacity, weak demand and excessive debt in a few hands. Given that private investors will not invest in new projects without visibility on payoffs, investments are likely to revive with demand growth. Yes, if the RBI aggressively slashes rates by 200 basis points or so, as KV Kamath recently suggested, Indian consumers may resume their big-ticket purchases, giving the economy a lift. But given the fluidity of global indicators, the central bank has no option but to proceed cautiously and incrementally.

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