The Reserve Bank of India’s monetary policy statement of June ticked all the right boxes. It delivered the predicted 25 basis point policy rate cut. It said the policy stance had moved from “neutral” to “accommodative”, which suggests that further rate cuts could be in the offing. It mentioned that the system had moved to surplus liquidity in June.
But nagging questions remain. One is whether liquidity is adequate to ensure complete transmission of the cumulative cut in policy rates of 75 basis points over the last three monetary policy statements. Out of the 50 basis point (bp) cut in the policy rate prior to the latest statement, 40 bp has been transmitted to the yield on 10-year government securities. However, only 21 bp has been transmitted to the weighted average lending rates.
The RBI Governor said “adequate” liquidity would be available in the system for all productive purposes. What is adequate liquidity? The central bank appears to be guided by the call money rate, whether it is close to the repo rate or not. This may not be the right indicator for judging liquidity in relation to economic growth.
The call money rate could be low because a few large banks have excess funds while small banks cannot borrow beyond a point because of limits on overnight borrowings. Banks may be able to borrow but they cannot lend because they lack enough regulatory capital. The time may have come to provide a liquidity target that the market can readily track and that reflects the growth needs of the economy. The old-fashioned would swear by M3, the broad measure of money supply. Why not restore it? Or provide an equivalent indicator?
Another troubling question: Is there enough liquidity to ward off financial instability? For several months now, the markets have been jittery about systemic risks posed by NBFCs. The jitters have increased following the downgrades of two well-known NBFCs. The RBI doesn’t seem to share the markets’ nervousness. The policy statement makes no mention of NBFCs. The RBI has made clear time and again that it does not believe in providing any special liquidity window for NBFCs. It has preferred to focus on overall liquidity and has left it to banks to channel funds to NBFCs on merits.
In his interaction with the media, the RBI Governor seemed to exude a certain confidence about the RBI’s assessment of the sector. The RBI, he said, was monitoring developments and was committed to ensuring a “robust, well-functioning NBFC sector”. It would take steps required to ensure that developments in the sector did not impact financial stability. The media discerned in the statement echoes of ECB President Mario Draghi’s famous quip about doing “whatever it takes” to protect the euro.
So far, the RBI’s assessment about the NBFC sector has turned out to be correct. Doomsayers had forecast a “Lehman moment” on account of NBFCs last October. We survived. Then they said that the NBFC sector would have to cross a hump in May. No sign again of a systemic crisis.
If the RBI thinks it has a grip on financial stability, that’s great news. But it’s not enough that the system doesn’t go belly up. Economic growth is flagging. Since NBFCs cannot grow credit as in the past, banks have to fill the gap. Ensuring liquidity is only one part of the story. The other part is providing adequate capital to public sector banks. The big question is whether the finance minister can muster the necessary capital without help from the Bimal Jalan committee on the RBI’s economic capital framework.
Mr Subramanian’s bombshell
Arvind Subramanian’s working paper highlighting the over-estimation of GDP growth in the period 2012-16 has proved less explosive than it seemed at first sight. For a couple of days, habitual BJP-baiters had a field day claiming that the government’s economic achievements had been inflated. (They seemed to overlook the fact that three out of the five years covered by Mr Subramanian’s findings pertain to the UPA government). But the initial shock at being told that the Indian economy had been reduced to 4.5 per cent crawl seems to have dissipated.
You can’t ascribe it entirely to astute media management. Had the findings been credible, foreign investors would have reacted. If India is not the fastest growing large economy, it undermines a key premise on which India has been attracting capital flows. We would have heard from investors, investment bankers and rating agencies. There’s been a resounding silence.
A fair inference is that the markets are reluctant to buy Mr Subramanian’s thesis. Leaving aside methodological issues, Mr Subramanian doesn’t tell us what went wrong in 2012-16. What economic shock caused growth to slump to an average of 4.5 per cent after decades of higher growth?
One plausible factor is the as yet unresolved banking crisis. The Economic Survey of 2016-17, prepared during Mr Subramanian’s stint as chief economic adviser, entirely discounted this factor. The Survey noted that, unlike in the US, Europe and Japan, “….. it (the twin balance sheet problem) co-existed with strong levels of aggregate domestic demand, as reflected in high levels of growth…” This was more than two years into Mr Subramanian’s term.
Mr Subramanian might have circulated his paper more widely amongst academics and amongst the government’s agencies and invited a critique before publishing it. His rushing into print with findings that are potentially damaging to India’s economic standing has not helped the cause of imported economists.
The writer is professor at IIM Ahmedabad. email@example.com