RBI monetary policy: MPC may be readying to fire its final weapon; likely a wrong one, aimed at a faraway target

  • In the backdrop of a worrying economic growth scenario, the Reserve Bank of India's (RBI) MPC is faced with a tough task

  • Past evidence shows that banks have only passed on 30-40 bps to the end-borrower despite the 135 bps cut in rates so far, meaning that monetary policy has found itself a weak weapon to influence the banking system effect a proper monetary transmission

  • In the last policy, the MPC had cut its annual growth forecast for the fiscal to 6.1 percent citing risks to growth

A worsening economic scenario leaves not much choice to the monetary policy committee (MPC), whose meeting is underway, except to go in for a sixth consecutive rate cut in policy rates. If it does a quarter percentage point, that will take the total quantum of rate cuts in this cycle to 160 basis points or bps. One bps is one-hundredth of a percentage point.

In the backdrop of a worrying economic growth scenario, the Reserve Bank of India (RBI) MPC is faced with a tough task. Past evidence shows that banks have only passed on 30-40 bps to the end-borrower despite the 135 bps cut in rates so far, meaning that monetary policy has found itself a weak weapon to influence the banking system effect a proper monetary transmission. Banks simply do not want to cut lending rates by a bigger margin for a very specific reason. Even if they do that, there is no strong demand from both large and small borrowers for money in a slowing economy.

 RBI monetary policy: MPC may be readying to fire its final weapon; likely a wrong one, aimed at a faraway target

File image of RBI governor Shaktikanta Das. Reuters

It is not the cost of money but the lack of demand on the ground that is actually hurting credit growth. The point here is even if the RBI/MPC goes for the sixth cut on Thursday (5 December), the point is no one would really care about it, maybe with the exception of stock markets that may dance for a few hours. The MPC is facing a real dilemma. It cannot go for a bigger cut now; inflation is inching up overshooting the central bank’s target. The attest reading of the annual retail inflation shows a jump to 4.62 percent in October, well above the 4 percent mark for the first time in 15 months and up from 3.99 percent in September.

The MPC needs to be watchful of the inflation scenario. It cannot solely focus on growth, even if that would be what the ruling BJP government would want from the MPC at this juncture. Union Finance Minister Nirmala Sitharaman is looking for ideas to save the economy beyond the steps that have already been announced.

Growth slowing

In the last policy, the MPC had cut its annual growth forecast for the fiscal to 6.1 percent citing risks to growth. Even 6.1 percent looks unattainable at this stage. The MPC will most likely go for another downward revision this time.

India’s GDP for the July-September quarter has come at 4.5 percent, the lowest growth in at least six-and-half years or in 26 quarters and even worse than the first quarter when the economy grew at 5 percent. This also means that if the Indian economy needs to grow at even 6 percent for the full year, the GDP growth in the second half needs to be an average 7.2 percent, which looks improbable as of now.

The full-year growth is likely to end up around 5 percent going by the current cues. More importantly, one must also take note of the big fall in nominal GDP growth that has come at just 6.1 percent, the lowest in so many years. This means the $5-trillion economy target is a distant dream now, forget the year 2025. According to NITI Aayog’s estimates, India needs to grow at 12.4 percent nominal GDP rate over the next five years to reach the $5-trillion economy target. That’s unlikely.

Over the years, the RBI monetary policy has become a non-event for the borrower. Even if the RBI cuts rates, that wouldn’t translate into a meaningful rate reduction for the borrower.

For instance, a back-of-the-envelope calculation shows that at a rate of 9 percent interest, the EMI for a Rs 20 lakh loan taken for 20 years tenure stands at Rs 17,995. If the rate is reduced by 25 bps to 8.75 percent, the EMI comes down to Rs 17,674, a difference of just Rs 321. Currently, banks charge a home loan borrower an average of 9 percent. A 30-40 bps reduction in lending rates means that EMIs will come down by Rs 400-Rs 500. This is hardly an incentive for anyone to take a new loan or an existing borrower to rejoice on his lower interest rate burden.

The current phase of economic slowdown requires fiscal response rather than a monetary stimulus. As mentioned earlier, right now the problem is more on account of a lack of demand. The government needs to put more money in the hands of people so that they can start spending on goods and services. Sitharaman’s recent comment that a personal income tax rate cut is in the offing sounds like a step in the right direction.

(Data inputs by Kishor Kadam)

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Updated Date: Dec 04, 2019 11:50:45 IST