The change in stance to “accommodative" means there is a possibility of further monetary easing in the months ahead. This policy is also important for a different reason: the accompanying statement on developmental and regulatory policies include two measures that seemingly seek to relax restrictive policy architecture introduced in the recent past. One, the leverage ratio for banks—which is now being relaxed to allow banks to lend more—was part of the revised prompt corrective action framework introduced in April 2017. Two, RBI also proposes to review the existing liquidity management framework, which was introduced in September 2014 and drew on the Urjit Patel panel report on revising and strengthening the monetary policy framework.
After Thursday’s changes, the repo rate stands reduced to 5.75% from 6% and the reverse repo rate stands adjusted to 5.5%. RBI’s monetary policy committee felt that the rate cut was in consonance with its medium-term objective of targeting consumer price inflation at 4%, within a band of plus-minus 2%.
The rate cut comes days after the government reported that economic growth slowed sharply to a five-year low of 5.8% in the three months to 31 March. The newly elected Narendra Modi government will need the economy to grow at a much faster pace to create jobs for the more than 1 million Indians who enter the workforce every month and lift more people out of poverty.
“The RBI decision to change the policy stance to ‘accommodative’ will simultaneously help the financial system navigate to a lower-term structure of interest rates and also accommodate growth concerns," said Rajnish Kumar, chairman of the State Bank of India, the country’s largest lender.
Interestingly, the 25 bps rate cut was endorsed by all members of RBI’s monetary policy committee (MPC) in a rare show of unanimity, unlike earlier occasions when there were always some dissenters.
Although the rate cut and change in stance was largely in line with expectations, stock markets were unhappy with the policy lacking any definitive relief measures for non-banking financial companies (NBFCs), which have been battling liquidity and debt repayment pressures, primarily due to a skewed asset-liability profile. There are widespread apprehensions that a collapse or bankruptcy in any one large NBFC can lead to systemic contagion due to the financial sector’s interconnectedness.
The disappointment was reflected in benchmark Sensex and Nifty closing 1.38% and 1.48% lower, respectively. The Nifty banking index shed 2.32%; similarly, the Nifty financial services index fell 1.94%.
RBI’s rate policy has been driven primarily by a slowing domestic economy, marked by a widening of the output gap, and global headwinds reflecting slowing manufacturing and trade activity. RBI’s second bimonthly monetary policy statement read, “a sharp slowdown in investment activity along with a continuing moderation in private consumption growth is a matter of concern". This has forced the central bank to shave its gross domestic product growth projection by 20 bps to 7% for FY20.
While concerns also abound on the price front—emanating primarily from an unpredictable monsoon, rising food inflation and volatile global crude prices—MPC does not see too much deviation from the baseline inflation trajectory set out in the flexible inflation targeting mandate. In its revised inflation projections, RBI has forecast marginally higher inflation for the first half of FY20 but also a marginally lower inflation print for the second half.
This has given MPC room to move ahead with a rate cut; the policy statement expects the lower rate to stimulate aggregate demand and reinvigorate private investment.
In addition, the central bank is also relaxing regulatory lending restrictions for commercial banks. RBI’s statement on developmental and regulatory policies include a relaxation in the leverage ratio for banks, which should help them expand their lending activities. The leverage ratio, as defined under Basel norms, is tier-I capital as a percentage of a bank’s exposures. A lowering of the ratio, with the capital as numerator staying fixed, would imply an expansion of the denominator, or the bank’s lending activity.
Two other issues needed addressing—concerns over liquidity tightness and NBFCs—and the central bank has managed to tackle only one substantially. RBI has effectively managed to sort out the first, with systemic liquidity turning into an average daily surplus of ₹66,000 crore in June from a deficit position in April and May. This is the result of daily liquidity injections, open market operations and long-term foreign exchange swaps conducted during April and May. RBI governor Shaktikanta Das said, “RBI will ensure adequate liquidity in system to meet productive requirements."
The expectation that RBI would devise some kind of a rescue plan for NBFCs remains unfulfilled. Das refused to spell out the central bank’s plans, except to say, “We are closely monitoring the activity, performance and development of NBFCs and large housing finance companies." He also said that since RBI was tasked with maintaining financial stability, it would not hesitate to step in or act if any development in the NBFC sector was deemed to have an adverse impact on financial stability.
There was another elephant in the room: stodgy transmission of rates. Commercial banks have so far not reduced their lending rates commensurate with the 50 bps cumulative repo rate cut in February and April. “While transmission of rates usually takes 4-6 months, the speed has not increased and we expect faster and higher transmission going forward," Das said.
“While the rate transmission so far by the banks have only been modest in relation to the rate cuts announced, a pickup in the pace of monetary transmission would be one of the key drivers in supporting the growth estimates for the current year," said Naresh Takkar, managing director and group chief executive of rating company Icra Ltd.
Das, however, provided some clarifications on the other notable omission: the policy document or the accompanying statement had no mention of the new framework that is expected to replace last year’s controversial 12 February circular for recognizing and resolving bad loans. He promised that something on this was likely to be announced soon.