RBI policy decision: Unless banks listen to Rajan, industrial growth is at risk

The Reserve Bank Of India’s governor followed a well laid down script, and most central bank watchers should pay credence to it. The Governor does not believe in making any rate cuts in the monetary policy. This time as always there is no justification given for not reducing the rates in the policy document. There are concerns as usual on the domestic economy and more on the global front. The RBI is concerned about the slow recovery in US, and very concerned about what is happening with the economy in China. The assessment by Raghuram Rajan says, “Growth continues to slow in China amidst financial fragilities and macroeconomic imbalances. This will have regional and global ramifications, although the softness in international commodity prices is providing some offset for net importers while adversely impacting net exporters.” A slowdown in growth in China has ramifications for the global economy, though how much is Indian economy now coupled with the Chinese economy it does not specify. [caption id=“attachment_2189123” align=“alignleft” width=“380”]  Rajan at the RBI policy meet. PTI image[/caption] Rajan, says in the policy that,” Global growth is likely to firm up through 2015 and 2016, supported by stronger recovery in the advanced economies (AEs) and soft energy prices. Downside risks mainly emanate from the slowdown in China, geopolitical risks surrounding oil prices and the uneven effects of currency and commodity price movements.” All these are very genuine concerns and issues from a professor of economy looking at the global economy, and they play a role in domestic growth. But do these factors outweigh the domestic factors so much that they deserve to be addressed first and domestic factors only later? The RBI is not very gung-ho on growth per se. It sees export margins shrinking, sounds a skeptical note on growth in services, sees manufacturing picking up but is concerned about the continuing slowdown in consumer durables segment. It is not very optimistic that the low rate of inflation will continue as it is driven by fall in global oil prices and now the unseasonal rains will affect prices of coarse grains at least. The RBI says that 17 per cent of the sowing area for rabi crop seems to be affected adversely in the unseasonal rains in the last two weeks. Moreover, inflation in high protein food items continues. While RBI’s stated policy is inflation targeting and to keep it in the range of 2 per cent to 6 per cent, it is now around 5 per cent. RBI policy talks about easing the short term liquidity in the market, but it does not talk about the real challenge that the banks and corporate are facing. Banks are not lending and they are preferring to keep their funds in SLR to the extent of 6-7 % over the statutory requirement. Therefore even if there was an SLR cut it would not have released liquidity into the market. The liquidity exists inside banks but not in terms of availability of credit for the corporate. This is the challenge that RBI or more importantly Ministry of Finance has to address. While RBI has little control over credit flows to corporates, the Ministry of Finance has better tools to apply pressure at least on the PSU banks. Even if the banks cut interest rates, or pass on the 50 bps rate cuts since January, it will only help ease the interest burden on existing loans that form the bottom line of companies. The immediate impact of it will be to justify their high valuation in the stock market it will not boost the economy. Banks are facing a slowdown in both credit and deposit rates. This combined with high proportion of NPAs and restructuring of loans in the books of PSUs. Moreover, PSU banks also need funds for their low tier-I capital and are not expanding credit to risk prone sectors. There is almost a state of freeze when it comes to lending to several sectors like real estate. The lack of transmission of the rate cuts by the banks shows they are willing to annoy the RBI and even the government as they are really concerned about their net interest margins. Corporates who want funding are accessing the corporate debt market and for the first time the funding from this market is exceeds that from banks. In such a scenario companies are moving beyond the banking structure to fund expansion or operations. The debt market rates are also falling faster while the bank interest rates remain static therefore the brown field expansion in several sector will possibly happen with the help of the banking sector. But the debt market cannot fully fund a economic growth and capital expenditure cannot be totally dependent on it. Therefore, even though the RBI may not talk about the elephant in the room and MoF may be pushing the wrong levers, a full scale capex recovery is not near on the horizon. K Yatish Rajawat is a senior journalist based in Delhi, he tweets @yatishrajawat