There was a time when the word “decoupled" had acquired an unassailable quality. In 2007-08, as the US financial sector was headed to hell in a hand-basket, many Indian financial experts (especially in capital markets) had proudly declared that the country was immune to the fallout because it had “decoupled" from the global economy. Little is known about the economic models that helped facilitate that conclusion, but this column does not want to judge; history already has.

Yet, it must be admitted, the term “decoupling" seems to have acquired some resonance in today’s domestic market. At least one prominent example jumps out—the decoupling of economic growth from monetary policy. After a relentless eight-month rate-cutting fest between February and October, the Reserve Bank of India (RBI) has lowered its benchmark interest rate by a cumulative 135 basis points. Pressure from assorted lobbies created a compelling chorus about how only lower interest rates could stimulate economic growth. Many economic pundits, nourished on an anachronous diet of monetarism and conservative economic philosophy, also seemed to have some purchase on the government’s economic administration and RBI’s thinking. Consequently, there was an emphasis on an accommodative monetary policy accompanied by procyclical fiscal contraction.

This has demonstrably failed to have an impact on growth impulses. On the contrary, India’s gross domestic product (GDP) has been in sequential decline over the past few quarters, despite the easy-money policy and surplus liquidity. GDP growth for the July-September 2019 quarter printed at 4.5%, slower than the 5% in the previous quarter.

RBI’s Monetary Policy Committee finally hit the pause button in its December meeting and passed the baton on to the government for an alternative solution. As an aside, this column has been advocating a fiscal stimulus alongside accommodative monetary policy; many other Mint columnists have also started pushing for a fiscal solution.

There is, of course, a handy stooge available to explain why monetary action has failed to translate into economic growth: Sticky monetary transmission. RBI alludes to it in almost every policy statement to demonstrate how rate cutting is not translating into lower bank lending rates. It is well known how the commercial banking system, which dominates the credit channel, is fast in responding to interest rate increases but relatively slow in a declining rate regime. This assumes importance because, as the Urjit Patel committee on strengthening and revising the monetary policy framework had underlined, rate transmission has become the “cornerstone" of monetary policy in most economies.

RBI’s December policy statement shows that against the cumulative policy rate cut of 135 basis points, the weighted average lending rate for fresh rupee loans declined by only 44 basis points. There’s also no dearth of liquidity: RBI absorbed 7,57,643 crore of surplus liquidity from the system in just five days (18-22 November). At current exchange rates, that is nearly $107 billion.

Admittedly, monetary transmission remains a problem for India. Here, it works through multiple channels: Interest rates, credit market, foreign exchange rates, asset prices and expectations.

Numerous papers have also explored the issue. A 2015 working paper from the International Monetary Fund (IMF), authored by Sonali Das, finds that the pass-through of policy rate changes to bank lending rates is slow, although deposit rates react faster to changes in the policy rate. An August 2016 paper from the IMF, authored by Prachi Mishra, Peter Montiel and Rajeswari Sengupta, contends that while there was proof of pass-through from policy rates to lending rates, albeit slowly and partially, there was no evidence of a second-order transmission from monetary policy to aggregate demand, especially because the small size of the formal financial sector dampens the effect of lower bank lending rates on aggregate demand.

There’s another astounding revelation in RBI policy document. Compared to the credit market’s sticky transmission process, various debt market segments have lowered rates by more than the 135-basis-point reduction in the policy rate: 137 basis points in the overnight call money market to 218 basis points for three-month commercial papers (CPs) issued by non-banking financial companies (NBFCs). A flight to safety seems to be the primary reason.

This also reflects the true emotions in credit markets: Fear and uncertainty. Banks are the primary investors in CPs issued by NBFCs. With the collapse of trust and confidence in the usual credit channels—given the unabated accumulation of bad loans and the unravelling of dodgy governance practices in NBFCs, private equity funds and mutual funds—banks have become credit-averse. No amount of rate-cutting will change that. IL&FS, Jet Airways, Café Coffee Day, DHFL, PMC, Karvy, Altico etc., the list continues to expand. Some state governments have added to the air of mistrust by threatening to scrap ongoing infrastructure projects. And then, there’s a sword of anxiety hanging over the telecom sector. Banks need credible projects to lend to, where they are sure of regular repayments, before the system freezes up completely. This is a state of emergency and the market appears incapable of sorting this out. At least for now.

Rajrishi Singhal is consulting editor of Mint. His Twitter handle is @rajrishisinghal