The latest policy rate cut by the Reserve Bank of India (RBI) is a slight surprise. It has reduced its repurchase rate, the effective rate of interest at which it lends money to commercial banks, by a little over one-third of a percentage point: by 35 basis points, to be precise. Traditionally, the central bank has moved its key rate up and down by 25 basis points, or in multiples thereof. RBI governor Shaktikanta Das argued that 25 basis points would have been inadequate, while 50 basis points would have been excessive. So, a middle path was chosen. What this suggests is that RBI is worried about the deepening economic slowdown, but doesn’t want to send out a panic signal by easing monetary conditions too much, too fast. This may be the best it could have done under the circumstances, grim as they are. On the evidence of a wide range of indicators, the downturn in the Indian economy has not yet been arrested, let alone reversed. The central bank now expects India’s gross domestic product to clock 6.9% growth this fiscal year, a tad lower than its previous forecast of 7%. Official growth in the January-March quarter of 2018-19 had dipped to 5.8%, and, if the first quarter of 2019-20 does not show an uptick, then it would take a sharp rebound in the last three quarters of the year for RBI’s revised number to hold good. Of course, the central bank does have space for further cuts. Inflation is projected to stay comfortably below the central bank’s 4% target all through the year, so overheating is not a fear.
Of greater concern is the ineffectiveness of past rate reductions in supporting growth. That’s because banks, faced with slowing deposits and tight liquidity, have not been able to reduce their deposit rates enough to make their loans much cheaper. In theory, efficiency gains could help banks operate on thinner spreads between the rates at which they borrow and the ones they lend at, but lack of genuine competition in the market has meant that most banks maintain bloated cost structures. This results in cost-plus credit pricing. By RBI’s own admission, the weighted average lending rate of banks for fresh rupee loans came down by a mere 29 basis points between February and June, which is less than half of the 75 basis points of cuts it had announced during that period. Investors would have liked more action on addressing this transmission problem, but the policy seemed to disappoint.
To be sure, liquidity in the banking system has turned surplus lately. But the effect has been uneven. Non-banking financial companies (NBFCs), for instance, are still starved of funds—which holds back commercial activity in sectors such as real estate. To some relief, RBI has lifted the individual exposure limit of banks to a single NBFC from 15% to 20% of their Tier I capital. This may enable some banks to increase lending. But, in general, it may not help much since most banks don’t have such a large exposure to any single NBFC. Also, for the purpose of capital buffer calculations, RBI has lowered the risk weight assigned to consumer credit from 125% to 100%. This could free up some additional capital for loans. But collectively, these new measures seem too small to tide over the crisis our economy faces. But then, there’s not much more that the central bank can do. For a proper economic revival, all eyes must turn to New Delhi.