RBI monetary policy: A reluctant Urjit Patel gifts a token 25 bps rate cut; ball in govt's court now

By offering a token 25 bps policy rate reduction to the rate cut lobby, Reserve Bank of India (RBI) governor Urjit Patel and his team at the Monetary Policy Committee (MPC) have effectively passed the ball to the government’s court. The panel has pointed out to the government where it needs to act urgently with regard to the economy, mainly by reviving the private investment scenario. If one goes by the signals of the monetary policy document, this could very well be the last rate cut of this fiscal year. The justification for today’s reluctant rate cut in the policy document is shadowed by an important caution on why the MPC will be even more watchful ahead in the inflation fight.

Indeed, it talks about some gap opening up for monetary accommodation on account of easing inflation, good monsoon and the smooth goods and services tax (GST) rollout so far, but not without a strong caution. Take a look at this line. “The trajectory of inflation in the baseline projection is expected to rise from current lows, the MPC decided to keep the policy stance neutral and to watch incoming data. The MPC remains focused on its commitment to keeping headline inflation close to 4 percent on a durable basis.”

RBI Governor Urjit Patel. AFP

RBI Governor Urjit Patel. AFP

The MPC was under tremendous pressure both from the North Block and the industry lobbies to cut rates. It has given in to the demand for now. The chorus was growing stronger by every passing day beyond decibel levels that Urjit Patel and his colleagues at the MPC could not ignore. A sharp drop in consumer inflation in recent months was a compelling factor for most economists to bet on a quarter percentage point rate cut. Some even predicted a 50 bps cut. The government machinery, not surprisingly, made a strong case for rate cut which came with the chief economic advisor to the government, Arvind Subramanian, nudging the rate panel to examine the possibility of monetary easing after the Consumer Price Index (CPI) slowed to 1.54 percent in June from 2.18 percent in May.

What is interesting is that the fundamental reasons that has prompted Patel and his fellow members to hold rates in previous policies aren’t non-existent even now— a still relatively high core inflation, play of base effects on the CPI numbers, the question of whether the recent dip in CPI numbers is a temporary blip or not, lack of clarity on the full impact of central allowances disbursal and monsoon. Some time back, the rate panel had surprisingly changed its stance from ‘accommodative’ to ‘neutral’ drawing flak from a section of economists for the hurried action. Even in today’s policy, there is a bit of irony in the MPC going for a rate cut even when it keeps the monetary stance ‘neutral.’

repo rate

At best, today's 25 bps rate cut can be seen as a reluctant action to appease the rate cut lobby, more than a convincing move from the rate panel. But, what is also not to be missed is the clear caution from the panel to the government where it needs to act to revive the economy.

“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. This hinges on speedier clearance of projects by the States,” the MPC has said.

The theory that rate cut can work wonders to boost the economy anyway doesn’t have many takers. The problems in the economy are many, not just high borrowing costs. Banks are flush with money after demonetisation but haven’t been able to deploy these funds in the industry because there is no major demand. The high amount of bad loans on the books of banks we see today is partly due to years of reckless lending to unworthy corporate borrowers. As a result, the banking industry is currently going through a painful clean-up exercise and it would take many more years for these entities to undo the past mistakes. The point of citing this is to say that a rate cut wouldn’t prompt banks to start lending in a major way unless the economic situation improves on the ground.

In fact, even before the rate cut from the MPC, the banking industry has already signaled a downward trend on interest rates with market leader State Bank of India slashing the savings bank interest rate by half a percentage point. Other banks will likely follow suit soon. The banking system has hardly followed the cues from the central bank’s monetary policies in the past — something highlighted by both Patel and Raghuram Rajan, the previous RBI governor. The 25 bps rate cut today may thrill the stock and bond markets for a while but is otherwise a non-event for the common borrower. More than the token rate cut, what one shouldn’t miss is the message in the policy document to the government on private investments and infrastructure problems. The ball is in the government’s court now.

Updated Date: Aug 02, 2017 17:35 PM

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