RBI governor is often looked at as the messiah who will not only keep prices in check but also take economic growth to new highs. It’s not new to want a rate cut every time the RBI and MPC review the monetary policy. This time, the Urjit Patel-led MPC has obliged with a 25 basis points cut, taking the repo rate to an almost 7-year low of 6%. But, guess what, it’s not enough to help spur GDP growth. For one, transmission of these rate cuts is essential. For another, the policy statement itself stresses on the “urgent need” to “reinvigorate private investment, remove infrastructure bottlenecks and provide a major thrust to the Pradhan Mantri Awas Yojana for housing needs of all.”
For GDP to grow, the biggest factor at work is demand. With enough demand, the private sector has the incentive to invest. But demand recovery has been slow, and in fact to a certain extent inadvertently been dented by factors such demonetisation and GST, feel economists.
Dr Arun Singh, Lead Economist at Dun and Bradstreet is of the view that green shoots on the demand front were visible late last year. “Then demonetisation happened and within 6-8 months of that GST was implemented. These two factors pushed back demand revival further,” he tells FE Online. “As of now, the private sector is troubled with capacity under-utilisation and the fact that banks are reluctant to lend due to the NPA crisis. Also, even though the RBI has cut repo rate by 25 basis points, transmission is key to the revival of private sector investment. Traditionally, it takes anywhere between 6 months to 1 year for banks to pass on the benefit of a rate cut,” Singh explains.
Watch: RBI Cuts Repo Rate To Almost 7-Year Low Of 6%
Sachchidanand Shukla, Chief Economist at Mahindra & Mahindra also believes that “…even as the RBI looks into the issue of effective transmission, there are too many one-off factors such as demonetisation followed by GST etc that make the near term hazy.” “RBI has cut rates, but as has been stated in the past by the central bank itself, the transmission has been imperfect. In this interest rate cycle, as many as 200 basis points rate cut has happened, but banks have been unable to pass on the entire benefit,” Shukla tells FE Online. “Also, there is excess liquidity in the system, which is not helping. In certain areas, such as retail and on the consumer front, transmission is happening, but the corporate lending remains constrained. Banks are struggling with NPAs and there is a lack of confidence to lend and borrow. Also, capacity under-utilisation adds to the woes of the private sector,” he notes.
Recovery on the horizon?
It’s still at least 6 months to 1 year away! Private investment demand is still at least 12 months away, says Shukla of M&M. “How private demand can be stimulated is a tricky question – the world over many economies have tried doing it by maintaining zero interest, but private capital expenditure or capex has not improved. Unless real demand exists, there is little incentive for the corporate sector to put in more money or expand capacities,” he rues.
Singh of Dun and Bradstreet feels that to some demand revival will happen with the help of good monsoon and to an extent even farm loans waiver. “On the urban front, the marginal benefit that banks will be able to pass on in the form on lower EMIs, will also push demand up. But, in the long run, corporate investment has to kick start, and that will take time till confidence is restored and banks get comfortable with their balance sheets,” he concludes.
As pointed out by economists, lag in transmission of rate cuts, and short-term impact of first demonetisation and then GST have pushed backed revival of demand and hence economic growth. At a time when public finances are constrained (given fiscal deficit target and farm loan waivers), it becomes even more critical for the Modi government and the RBI to hasten the process of solving the banking NPA crisis and enable the right economic environment for businesses to flourish.