Delivering beyond expectations
There has rarely been a Reserve Bank of India (RBI) policy that has maintained the status quo on rates but delivered much beyond expectations. In a constrained optimisation environment, where space for policy rate cut was limited, the RBI has been able to maximise its support for growth through a series of unconventional monetary policy measures. While the focus has been on improving both the cost and availability of credit, the credibility of the inflation targeting framework has been preserved by keeping the policy rate unchanged.
The thrust of the announcements was towards altering the liquidity and macro-prudential frameworks to ensure better monetary policy transmission. The weighted average lending rate (WALR) on fresh rupee loans has declined 69 basis points (bps) and on 10-year G-sec by 76 bps in the last one year against policy rate cut of 135 bps despite several attempts, including external benchmarking of lending rates. Two changes in the liquidity framework should be emphasised. First, it appears that the earlier stance of banking system liquidity to be usually kept in deficit for better transmission has been abandoned. This implies that the banking system liquidity can remain in surplus mode much longer even if the economic cycle turns.
Second, to provide durable liquidity at a committed low cost, the RBI will be offering to lend 1-year and 3-year money to banks worth ~1 trillion at the policy repo rate. These announcements will buttress the RBI’S commitment of keeping the accommodative stance for longer and has already led to a 15-20 bp drop in interest rates at the short end of the curve.
To incentivise credit flow the RBI has also announced that banks will be exempt from CRR requirement on incremental loans to MSMES, autos and residential housing for a period till July 31, 2020. It is likely to reduce the borrowing costs for these troubled segments of the economy and improve flow of credit too. The decision to delay the classification of commercial real estate loans as NPA by one year and extend the restructuring of stressed MSMES loans would also provide much needed respite.
While we remain fully supportive of these measures, the following financial stability risks will have to be closely watched. Extremely surplus liquidity conditions, maintained over a sustained period, could potentially lead to asset price bubbles, particularly if the liquidity cannot find its way into the real economy. Also, if the banks have to move down the credit quality ladder in sectors where there is already competition for providing credit then the consequent asset quality impact has to be monitored, particularly in a slow growth environment.
The RBI has kept the door open for more easing but, in our view, any future rate cut can happen only after consumer price index (CPI) comes down to around 5 per cent and transmission of past rate cuts is in place. This provides only limited room when near-term inflation outlook is so uncertain. However, the policy has clearly underlined RBI’S growth focus and willingness to resort to unconventional steps to cap any up move in yields.
RBI has kept the door open for more easing, but a future rate cut can happen only after CPI comes down to around 5 per cent and transmission of past rate cuts is in place