RBI may cut repo, but bonds may still not yield

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Published: December 5, 2019 4:24:22 AM

With poor loan-demand, repo rate & transmission don’t matter as much; cleaning up NBFC mess is the priority.

Reserve Bank of India (RBI) governor Shaktikanta Das had observed recently that the central bank can’t be forcing the banks to lend. That is absolutely the right approach.

Never before has the repo rate been less relevant than it is currently. The real problem today is neither one of very high interest rates nor that of lack of transmission. It is that companies don’t want to make big investments, not too many individuals want to leverage, and banks, too, are reluctant to lend. So, it is both, a demand and supply problem.

At one level, subdued credit flows in the aftermath of the NBFC crisis are probably the biggest reason for the slowdown in the economy. The irony is that the system is awash with money—an average surplus of around `2 lakh crore, but loan growth is crawling; in the fortnight to November 8, it dropped to a two-year low of 7.9% year-on-year (y-o-y). Seen another way, loans between April and November 8 have increased by a mere 0.8%. The government’s outreach programme, initiated in October, has seen public sector banks open their cheque books; therefore, the loan growth in November may look better. But, the fact is, there is virtually no demand from companies for project finance, and very little for working capital limits. In Q2FY20, State Bank of India’s corporate portfolio grew a little over 2% y-o-y.

Banks can’t be blamed for not wanting to take on corporate risk; they have been badly burnt, and given the way the finances of companies are unravelling—there have been 3,300 downgrades in 2019 so far, or ten a day—they are justified in staying away from weak and potentially weak exposures.

Reserve Bank of India (RBI) governor Shaktikanta Das had observed recently that the central bank can’t be forcing the banks to lend. That is absolutely the right approach. Unfortunately, there is little the RBI can do right now to stimulate demand because even if banks lower interest rates, following a repo rate cut, companies are unlikely to rush to invest. SBI chairman Rajnish Kumar was right when he said companies don’t really worry too much about interest rates while making investments. At a time when private consumption demand is muted, pricing power is absent, and there is a lot of surplus capacity, there is little reason for them to create more capacity.

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Nonetheless, RBI should trim the repo, by about 25 basis points, to enable banks to lower their loan rates; it is possible that if loans get meaningfully cheaper,individuals may be willing to borrow to buy cars or two-wheelers. This is important because rising food inflation could, at the margin, hurt demand for other goods. For the moment, the central bank needs to look through what is probably a transient pressure on food prices—core inflation is, in any case, very low, tracking at just 2%—and make growth its only priority. Else, capacity utilisation will remain low for longer, the investment cycle will be slower to turn, and the long-term potential growth, too, will fall.

To be sure, there is a serious problem with the fisc since nominal GDP is now expected to grow at just 8-9% this year, and not 12% as budgeted, but this is unlikely to stoke inflation as the demand is very poor. What RBI can do is to speed up the clean-up in the NBFC sector with an asset review, and facilitate consolidation in the space. Once the true quality of the balance sheets becomes known, it will be easier to revive credit flows.

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