Transmission problem remains

The Reserve Bank of India (RBI) responded as expected in its Monetary Policy Review, with a 25 basis points rate cut, and a switch in policy to “accommodative” from neutral. It released a gloomy advisory with a reduction in Gross Domestic Product (GDP) growth estimates while holding inflation estimates. The market nosedived, because optimists were expecting a 50 basis points cut.

Let’s look at this stance in the light of corporate data. Results for the second half of 2018-19 show that interest costs have risen for most companies. Interest payments are up 15 per cent Year-on-Year (YoY) for non-financials and non-oil companies, according to a study by Business Standard Research Bureau. At the same time, operating profits are down 6 per cent for the same set of 1,200 listed companies. Net profits are also down, by about 3.5 per cent YoY.

Capital investment was low. Inventory held was up 12.9 per cent YoY during H2FY19, outpacing revenue growth. In the same period, receivables were up 12.8 per cent. Total fixed assets (which is an indicator of capital investments) was up 9.7 per cent during H2FY19.

Combined borrowings were up 13.3 per cent YoY during H2FY19, compared to a decline of 3.3 per cent during H2FY18. The total outstanding debt of the sample rose to Rs  12.7 trillion against Rs  11.2 trillion a year ago. Averaged interest rates came to 9.04 per cent against 8.85 per cent, a year ago. However, the interest rate was down by around 24 basis points compared to H1FY19.  Another data-point of interest is that household debt has spiked since 2016-17, despite low consumption demand.

What we’re seeing here gels with the RBI’s policy statement. The economy has seen a demand slowdown with a working capital crunch, high interest rates for everyone and higher household debt, which might be at least partially due to high unemployment.  Due to slow conversion of receivables into cash, there’s been accumulation of inventory and cash flow problems.

The transmission of policy rate cuts to commercial rates also appears inefficient. The RBI last hiked policy rates in August 2018. It held rates in October and December. It changed rate-stance in February with the first of three successive rate cuts of 25 basis points each.

The policy rate is now 75 basis points lower than in August 2018. Indeed, rates are down to 2010 levels and that was when the UPA-II was tackling stage II of the global financial crisis.  But lower rates have not translated into commensurate drops in commercial rates.  Analysts estimate that about 20-25 basis points of the (earlier) 50 basis point cuts have been passed on so far. The RBI is setting up a working committee to address transmission.

Transmission of the rate cuts is imperative. That would allow corporates to refinance more cheaply and it may trigger demand.  What is not obvious is how the RBI will ensure that rate cuts are transmitted.

There are three intractable issues, which prevent efficient transmission. One is high banking non-performing assets, which makes banks reluctant to cut rates. The second problem, stress across the non-banking financial company (NBFC) sector, which makes it hard for NBFCs can’t borrow at lower rates and so, they can’t lend lower either. The third is the enormous quantum of government borrowing, which is clogging up the bond market.  

Government borrowing won’t come down. If we take into account off-balance sheet items, delayed payments, etc., the fiscal deficit was well above 4 per cent of GDP for 2018-19. Those delayed payments must be made. The   Government of India’s expenditure cannot be cut in 2019-20. It is committed to populism as per the election campaign.  In any event, cutting government expenditure would be the wrong approach to low demand.

The RBI is due to release a new circular on NPAs soon. The news on this front is mixed. After registering a loss of Rs 85,000 cr in 2017-18 as the RBI pushed for faster recognition, PSU banks have registered a loss of Rs 72,000 cr in 2018-19. There are some signs that NPAs are coming down. But given higher interest costs and lower profits, this remains an area of concern. The NBFC situation is also work-in-progress, what with DHFL and IL&FS. The market will have to deal with this. Until it does, there will be a problem with transmission. The RBI has done what it can but these problems remain.


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