Slowdown blues: RBI rate cuts not effective anymore, say analysts

The markets fell despite the rate cut
Analysts have started doubting if the interest rate cuts alone, beyond a point, are effective anymore when the economy is in a contraction mode, saying that the Reserve Bank of India (RBI) must look at other measures to nudge for a revival.

The government, meanwhile, will have to do much more as the economic packages announced remained inadequate to pull companies out of the slowdown pangs.

“While the RBI will keep interest rates under control, it appears unwilling to take on any credit risk on its own books. In turn, the finance ministry seems unwilling to offer any comprehensive package that might appear like a bailout of big business,” said Ananth Narayan, associate professor at SP Jain Institute of Management Research.

Between March 27 and May 22, the RBI reduced policy repo rate by 115 basis points. The repo rate stands at 4 per cent, and the reverse repo rate at 3.35 per cent. Yet, the RBI itself doesn’t seem to be sure that such rate cuts would encourage companies to borrow for their capex. The central bank expects a contraction in economic growth for fiscal 2020-21 and gradual recovery thereafter. This is also the first government institution that projected a contraction.
RBI Governor Shakikanta Das said, in his streamed address, that the six-member monetary policy committee (MPC) judged that the risks to growth were acute while those to inflation were likely to be short-lived. Therefore, it was essential to “instill confidence and ease financial conditions further”, in order to “facilitate the flow of funds at affordable rates and rekindle investment impulses”, Das said. And that’s how the rate cut and extension of moratorium schemes was decided upon.

The markets fell despite the rate cut. The markets had also fallen when the Centre laid out its Rs 20-trillion stimulus package, which was less than Rs 2 trillion in actual funds outgo from the fiscal side, while the rest hinged on guarantees and liquidity enhancing measures already taken by the RBI. The liquidity window offered for NBFCs also turned out only for three months, and which can be availed using bonds already issued by the NBFCs and held by investors. NBFCs do not get the benefit of this liquidity window at all, experts said.

Rate cuts were not enough. Sonal Varma, Nomura’s chief economist for India and Asia (ex-Japan), said: “The effectiveness of rate cuts and excess liquidity on delivering the growth bang is incrementally falling in a scenario of rising credit risk aversion.” So, the RBI must look at ‘unconventional’ monetary policy measures.

These measures could include focusing more on transmission, increasing held-to-maturity limit for banks, announcing a special calendar for open market operations, and focusing on the special purpose vehicle for NBFCs. Focus needs to be given to sector-specific measures.

However, some banks are silently raising the risk premium on loans, even as they are reducing the benchmark to show that they are passing on the rate cuts. This is defeating the transmission objective of the RBI, experts pointed out.

More urging need is addressing the non-performing assets of banks. Narayan estimates that bad debt in the banking system, which was roughly 12 per cent of the loan book, as high as 20 per cent due to the coronavirus pressures. “For now, India appears to be in an impasse, as far as addressing the issues around the financial services ecosystem,” Narayan said. Eventually, the government may have to come up with a comprehensive plan to revive the sector, but it is difficult to gauge when such a package may be forthcoming, according to Narayan. “Till then, the sector will likely stay stressed.”

According to Gaurav Kapur, chief economist of IndusInd Bank, the RBI has so far remained within the largely conventional bounds of monetary and credit policy, but “going forward, while there is still space for monetary easing through repo rate cut, the RBI may have to consider other measures, which could help improve the transmission of rates, credit offtake and distribution of excess liquidity.”

These measures could include opening up a repo window for good quality corporate bonds, considering that in the absence of credit growth banks’ investment in commercial paper, bonds, and shares of corporates have seen a sharp increase of Rs 66,760 crore, against a decline of Rs 8,820 in the same period last year, as of May 8. The corporate bond repo will improve transmission and help channelise liquidity in a better manner in the various corporate segments.

The RBI can introduce standing deposit facility and cap how much banks can park in the reverse repo window. Liquidity profile in banks is highly skewed, and this would dissuade banks with large surplus liquidity to passively deploy their funds in reverse repo window and place them in money market instruments and loans instead.”
According to Suyash Choudhary, head of fixed income at IDFC AMC, rates in the short term is considerably lower than reverse repo rate reflecting massive liquidity. The rate cut will further cut the short-term rates, and steepen the yield curve.

“However, traditional easing is rapidly diminishing in utility and effectiveness as it is not able to solve for either the substantial steepness of the curve (reflecting reluctance to take on duration risk) or the higher levels of spreads on lower-rated issuers (reflecting credit risk aversion).” The RBI can incentivise the deployment of existing capital by reducing perceived risks effectively and avoid medium-term cycle of perverse allocation that may “in turn end up causing bigger problems down the line than what gets solved now,” Choudhary said.

Low rates need not incentivise Indian firms to borrow, as the problem is not only the cost of funds, said experts. “Unlike advance economies, interest rate elasticity of aggregate demand and investment is low in India. While RBI has ensured adequate means of financing and liquidity in the banking system, impaired income streams and balance sheet of both households and industries are the biggest obstacles,” said Soumyajit Niyogi, associate director, India Ratings and Research.

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