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RBI cuts rate by 25 bps: If you believe good times are upon us now, think again

So, the rate cut has come, a full 25 bps. In all likelihood, that’ll be all from the inflation-targeting rate panel this year. What now? The rate-cut lobby must have slept peacefully on Wednesday night, dreaming good days the cut will bring to them. Struggling industries must be happy having got the 'miracle cure' they badly needed. Now that a 25 bps cut has come, banks will finally start lending to them after consistently not doing so in a big way in the past several years. The government will be too happy since the MPC has finally delivered the medicine that’ll now start working wonders to improve the fortunes of Asia’s third largest economy.

Yes, all these dreams are true provided we live in an unreal world. The reality, unfortunately, will tell us a different story.

The 25 bps RBI rate cut is actually a non-event for the banking sector and industries. It is not going to make life better for any of us. The talk of big gains the rate cut will bring to the world is, at best, a joke. One still don’t understand what does the trick for the rate-cut lobby to keep themselves motivated throughout the year.

 RBI cuts rate by 25 bps: If you believe good times are upon us now, think again


The reality is Wednesday’s rate cut is not going to make banks — habitually cautious profit-seekers — restart lending for the good of the society any better than what they have been doing already. This because of the simple reason that high lending rates aren’t the big reason why lending is not happening, particularly to industries.

The issue lies with poor demand from corporations and high bad loans banks are stuck with. The banks are also wary about the stricter scrutiny of every big loan deals they enter into, by investigative agencies rattled by the government’s diktat to chase loan defaulters. If one takes a look at the comments from economists post the RBI rate cut, the rate cut myth will be busted.

Indranil Pan, an economist at IDFC Bank Ltd does not believe (read a report here) that the RBI's rate reduction will kickstart lending. In a note to clients titled the "last hurrah", Pan also, said there's no room for more cuts through March 2018. Banks typically follow rate signals from the central bank’s repo rate changes only if the systemic liquidity is tight. When the banking system is flush with liquidity (which is the case after the demonetisation rush), banks are sitting on cash piles. Still, there has been not major pick up in lending.

Why? Because lack of liquidity is not the problem, not the interest rates; any experienced banker will tell you the big challenge for him is to find worthy corporate borrowers with viable business proposals. That is missing even now. New projects aren’t coming up in a big way and many projects where banks have already made financial commitments are stuck for a verity of reasons. The only area where the lending is happening is for the retail borrowers, such as housing and auto loans. Till economic reality changes on the ground, this scenario wouldn’t change. The industry lobbies which have been making a ruckus for the RBI's rate cut should actually pay attention to the Wednesday’s policy document a bit closely.

It talks about an urgent need for the government to unclog the infrastructure problems, reviving private investments and boosting the housing sector. “On the state of the economy, the MPC is of the view that there is an urgent need to reinvigorate private investment, remove infrastructure bottlenecks and provide a major thrust to the Pradhan Mantri Awas Yojana for housing needs of all,” it says.

A rate cut wouldn’t do that, economists remind us. "Monetary easing does not seem to be having any material impact on private investment, the momentum of which has deteriorated steadily," Kaushik Das, chief India economist at Deutsche Bank AG in Mumbai is quoted by the Bloomberg story cited above.

Big corporations have already moved to the money market where interest rates are lower. But, smaller companies with lower credit ratings aren’t that lucky. They will have to still depend on banks' money. But the lenders are highly reluctant to look at this category of customers since these firms are perceived as a high-risk category.

A significant chunk of bad loans accumulated by PSU banks are from small and medium company segment. But, even here, let’s not forget that interest cost constitutes only a fraction of their overall costs. Even to revive private investment, the government will have to work on a host of reforms, including making acquisition of land and labor easier and ensuring ease of doing business. It needs to take the investor community into confidence. Again, the monetary policy cannot do much here. It’s time the rate-cut lobby did a serious rethinking and called for more fiscal reforms.

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Updated Date: Aug 03, 2017 12:59:13 IST