Muted re­sponse to rate cut

Ei­ther the cut had been dis­counted, or smart money doesn’t see the stim­u­lus as ad­e­quate

Business Standard - - PERSONAL FINANCE - DEVANGSHU DATTA

The Mone­tary Pol­icy Com­mit­tee (MPC) took the plunge and re­versed stance. It cut the pol­icy rate by 25 ba­sis points and switched stance from “cal­i­brated tight­en­ing” to “neu­tral”, which means it will pump more money into the bond mar­ket. The stock mar­ket barely twitched through the pol­icy re­view ses­sion. The bulls were hop­ing for a 50 ba­sis points cut. The ru­pee strength­ened marginally.

The MPC has a good case. In­fla­tion hit 18-month lows in De­cem­ber and the RBI es­ti­mates some sort of growth slow­down at the mo­ment, given trends in high-speed in­di­ca­tors like auto sales. Low in­fla­tion and growth slow­down both sug­gest a looser mone­tary pol­icy.

The ex­traor­di­nar­ily low in­fla­tion is al­most en­tirely due to food prices go­ing neg­a­tive. Crude prices also dropped in De­cem­ber. Both those price bas­kets are volatile. Take­out food and fuel and core re­tail in­fla­tion is at 5.6 per cent. That’s also down from Novem­ber lev­els but it’s close to the high end of the RBI’s tol­er­ance of 6 per cent.

So the Con­sumer Price In­dex (which the Re­serve Bank of In­dia is man­dated to fol­low) may be un­der­es­ti­mat­ing in­fla­tion. Even so, in­fla­tion is low. If food prices don’t sud­denly jump and crude prices stay more or less sta­ble, the rate cut is rea­son­able.

Rates cuts are sup­posed to stim­u­late busi­ness ac­tiv­ity. The big ques­tion mark is, will the rate cuts be trans­mit­ted through the sys­tem to ben­e­fit com­mer­cial bor­row­ers? This may be un­likely. Pub­lic sec­tor banks (PSBs) re­main in poor shape and can­not af­ford to cut lend­ing rates. They are braced for a new bout of farm loan waivers.

The bond mar­ket is braced for huge govern­ment bor­row­ings. Govern­ment debt is, by def­i­ni­tion, safe, if rel­a­tively low-yield. It can be sub­scribed to by banks that are within the Prompt Cor­rec­tive Ac­tion (PCA) mech­a­nism, or skat­ing on the edge of PCA. That’s where the PSBs and debt mu­tual funds will be fo­cussed.

The govern­ment is go­ing to over­shoot its fis­cal deficit tar­gets con­sid­er­ably. If all the ac­count­ing jug­glery and late pay­ments of food sub­si­dies, etc, are ad­justed for, the cen­tral fis­cal deficit could well rise be­yond 4.5 per cent. The states will also bor­row more in an elec­tion year. Those govern­ment bonds and T-Bills will crowd out com­mer­cial bor­row­ings.

The mu­tual funds are also ner­vous about the po­ten­tial for de­faults. Af­ter IL&Fs, the al­le­ga­tions of a scam in DHFCL and the move by RCom to­wards bank­ruptcy have left debt mu­tual funds feel­ing ex­posed and ner­vous.

The new dis­pen­sa­tion at the RBI is ap­par­ently go­ing to look the other way at banks keep­ing a large dif­fer­en­tial be­tween bor­row­ing and lend­ing rates. The de­ci­sion that all float­ing rate loans would be bench­marked to an ex­ter­nal rate is now be­ing passed off as a “draft”. That might help banks gouge a higher NIM at the ex­pense of bor­row­ers.

It’s still not clear if the PSBs have gen­uinely started to cut down on their non-per­form­ing as­sets (NPAs) bur­den. Nor are there signs that due dili­gence has im­proved sub­stan­tially. Re­cap­i­tal­i­sa­tion is be­hind the curve and it’s not ob­vi­ous where the govern­ment can find the money to com­plete this process.

Ac­cord­ing to a new re­port from In­dia Rat­ings, up to ~3.5 tril­lion of stan­dard loans could turn into fresh NPAs over the next two years. The tele­com sec­tor re­mains un­der stress. So does real es­tate. The di­men­sions of the non-bank­ing fi­nan­cial ser­vices cri­sis are not yet clear. The In­sol­vency and Bank­ruptcy Code is not work­ing as quickly as it could.

This is where the real prob­lems for the RBI may lie. It has to open the taps, given low in­fla­tion and low growth. But banks are not in a po­si­tion to pass on those rate cuts and govern­ment bor­row­ing will crowd out com­mer­cial de­mand for loans. This means that the growth stim­u­lus from the rate cuts will be low.

Banks may pick up a fresh se­quence of NPAs and, if growth and prof­itabil­ity don’t im­prove, cor­po­rate loans cur­rently clas­si­fied as stan­dard could also turn into NPAs. This could mean an­other round of bank­ing crises.

The stock mar­ket’s muted re­sponse to the rate cut can be viewed in many ways. First, the cut had been dis­counted by many par­tic­i­pants and some were hop­ing for big­ger cuts. So there was some bull un­load­ing. Sec­ond, the smart money doesn’t see the stim­u­lus as ad­e­quate.

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