On Friday, the Reserve Bank of India (RBI) cut its policy rate for the fifth time in a row. This was along expected lines. The economy’s growth has slowed to a five-year low, inflation has largely been stable, below the central bank’s 4% target, and an accommodative stance was a given. Since February this year, RBI has slashed repo rates by as much as 135 basis points. Its repo rate, or the rate of interest at which it effectively lends money to commercial banks, is now 5.15%. With its growth forecast for this fiscal year reduced from 6.9% to 6.1%, a figure that seems far more realistic, few can argue against its action. Yet, doubts hover over the extent to which the actual availability of credit will be eased. To start with, policy transmission remains a bugbear, despite RBI’s efforts to have its cuts translate into cheaper and more plentiful loans for businesses, households and other borrowers. By its own admission, the interest cost that fresh debtors had to bear fell by a mere 29 basis points between February and August, though its repo rate was reduced by 110 basis points during this period. Worryingly, little has changed on this front since June, which means some of RBI’s cuts were just blank shots.
While lenders have recently been asked to link some lending rates with external benchmarks, the efficacy of such directives has always been disappointing in a state-dominated sector marked by low market rivalry, a poor record of risk assessment, a heap of rotten loans, conflicting incentives for bankers to lend or not, and an acute scarcity of low-cost funds in the face of higher rival rates offered by the government’s saving schemes. Besides, what ails our economy may increasingly have more to do with a lack of consumer demand than the high real cost of capital. With a sales contraction visible in several product markets, if returns look iffy, few businesses would want to invest in fresh production capacity. Also, many companies are already heavily indebted, while the shadow banking sector is still experiencing convulsions caused by a series of shocks over the past year. Credit flows appear to have suffered a seizure in big-ticket markets such as real estate, which has various projects entangled in a legal jumble. Under such circumstances, banks getting to access RBI funds a quarter of a percentage point cheaper can hardly be expected to have much effect.
If RBI has done its bit of monetary easing, the government has recently gone for fiscal easing. Except, the latter’s aim has been to ease the tax burden of India’s corporate sector, rather than put money directly in the hands of consumers. While the recent reduction in corporate tax could result in higher dividends for shareholders and help firms lower the prices of their wares, it is unlikely to fire up consumer demand. What is perhaps needed is a cut in personal income tax as well. People need money to spend. Overall tax collections are falling short of their budget target anyway, so keeping the fiscal deficit within 3.3% of gross domestic product is looking like a tall order. The fallout of this could complicate RBI’s course of action in the future if and when this big macro imbalance begins to push inflation and bond yields up. All policy moves would need to be calibrated carefully from then onwards, lest the economy’s basic stability comes under threat. For now, hopes of an economic upturn ride on the twin stimulus.