RBI Governor Raghuram Rajan not cutting repo rates is disappointing given even the central bank’s monetary policy statement acknowledges a positive softening of the inflation outlook. And that’s not surprising given how global commodity prices have collapsed, how crop support price hikes have been kept to the minimum and how savage the compression in government expenditure has been. Despite this, as in the past, RBI has talked of how the ‘base effects’ will wear out by December, so it is the inflation numbers after that which need to be closely monitored before a rate-cut decision is taken. While FE’s position has been there were no base effects to talk of over the past few months, the larger point is that RBI’s inflation outlook has also changed quite dramatically. Just two months ago, RBI’s central tendency was an inflation of around 7.75% in March 2015; today, that central tendency is at 6%, suggesting even RBI doesn’t believe the ‘base effect’ is as large as it is made out to be. Two months ago, RBI was talking of the balance of risks to its objective—6% CPI inflation by January 2016—being ‘to the upside’, this time around the policy says the risks ‘appear evenly balanced’. In other words, with most variables already favourable—Rajan did say he was looking to see how the fiscal targets were met, though few doubt there will be a problem—it is unfortunate the central bank chose to remain as cautious as it has.
While defending RBI’s role in not being pro-growth, Rajan repeated the point made by him last week on the role of high NPAs on keeping effective interest rates high. While RBI could be held responsible for banks not cutting their base rates, he correctly argued, it was high NPAs that determined the risk premium levels banks were charging—as he put it in his speech ‘Saving Credit’, the average interest rate on loans to the power sector today is 13.7% even while the policy rate is 8%. While the Governor announced that he would soon be coming out with a policy on the 5/25 loans, another important policy will be reverting to the earlier position where banks are free to take a higher equity position in projects they restructure—while the current limit is 10%, the Governor said a higher limit was allowed earlier. The exact contours of how this equity is to be priced are being discussed with Sebi, and banks will obviously be free to not take equity positions at all. While Rajan said a higher equity position will allow banks to benefit from the upside should the restructuring work, the move is fraught with risk and needs to be rethought. If banks are not able to get errant promoters to fall in line with a 10% stake, there is no reason why they will be able to do this with a 15-20% stake—it is only at a 26% level that banks have some kind of veto power, but taking that much equity in a project opens up banks to other kind of risks and getting involved in the daily running of the project. The Governor’s larger point of how banks need to get more pro-active when it comes to recovering their loans—and the government needs to help out as well—is, of course, well-taken.