The logo of Reserve Bank of India (RBI).  (Reuters)
The logo of Reserve Bank of India (RBI). (Reuters)

RBI has done its dharma, now it needs to be careful about karma

  • RBI has cut repo rate by 75 basis points in last 3 policy meets and brought liquidity to a surplus mode
  • Transmission of policy rate cuts onto lending rates is still low; govt bond yields have dipped sharply

The credit for the phenomenal drop in retail inflation, India’s biggest headache over the past several years, goes to its central bank.

Indeed, as former governor of the Reserve Bank of India (RBI) D. Subbarao said, it is the central bank’s dharma to manage inflation and RBI has delivered on it.

As of last count, retail inflation was still below 4%, a medium-term aspiration for decades that turned into a formal target in 2016.

With that out of the way, the focus point of policymakers obviously is the floundering economic growth.

Here is where RBI needs to be careful about its karma so far.

Its six-member monetary policy committee has voted for a cumulative 75 basis point cut in just six months’ time. RBI has also flushed the banking system with enough liquidity.

But the money isn’t flowing freely or even pushing banks to lend. That is because money doesn’t move unless it has trust with it.

That is why a liquidity surplus of over 2 trillion and rate cuts haven’t brought down bank lending rates. The weighted average lending rate on outstanding loans increased between January and May, while that of fresh loans fell by just 11 basis points. Add the crisis surrounding non-bank lenders, the impact on growth cannot be ignored.

The lack of transmission has two parts to it. The trust part is where the central bank can do little beyond what it has done already. Of course, it has to detail the liquidity framework that RBI promised at its previous meeting. “Markets would also wait for signalling from the central bank on whether it intends to keep liquidity in surplus for an extended period of time. This could also infuse confidence and in turn assist in better transmission of monetary policy," analysts at ICICI Bank Ltd said in a note.

What RBI can do is create conditions where trust can be cultivated.

That means making the government more honest about fiscal deficit in the first place.

Cumulative public sector borrowing is crowding out private sector borrowers, which is the second part of the transmission problem.

The rise of off-balance sheet borrowing even as the headline fiscal deficit remains at 3.3% of gross domestic product is skewing the pitch for transmission. This is coinciding with a steady decline in household savings, the backbone of funding in the country. With most of the savings cornered by the government, there is little left for private sector companies.

As banker to the exchequer, RBI needs to sensitize the government on the effect off-balance sheet borrowing has had on private sector borrowers. Surely, when the fiscal math is being questioned, the sovereign cannot enjoy lower cost of borrowing through a sharp drop in bond yields. Sovereign bond yields have dropped more than 60 basis points since the last policy meeting in June.

Governor Shaktikanta Das needs to show some tough love to the government or else the karma of his inaction would pose difficulties in future.

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