The outlook on inflation makes a strong case for pause in the accommodative stance the MPC has taken of late. While SMEs and other business still need access to easier credit, perhaps waiting till the revival happens before cutting rates further would be advisable
The outcome of the MPC meeting is always of interest to the market, as there is guesswork going on all the time on what the committee may decide on interest rates. If the economic conditions now are compared with those in May, when a call was taken on interest rates, there is considerable uncertainty on the ‘unlock’ process the government has talked. This is so because, while most manufacturing activity and some services have been allowed to recommence operations, periodic lockdowns at the state- or district-level leaves companies wondering about the future. Basic problems, such as of labour and logistics, remain, while liquidity has been more than addressed by the central bank.
The first question in the current context is whether RBI will lower the repo rate again this time. It is at 4%, and there is room for further cuts. But, inflation is above 6% and will remain at elevated levels for some more time until the kharif harvest sets in. This basic indicator is justification for a pause on the accommodative stance this time. However, this is a judgment call to be taken. Looking ahead, the inflation dynamics are going to shift, with non-food inflation being the variable to look at. The services segment, which dominates the core inflation part, has shown signs of moving up; and as services open up, this will become all-encompassing. Airline rates are up, as are those for healthcare as providers of such services make up lost ground. Hence, notwithstanding a good kharif crop, price pressures will remain, and an average CPI inflation of 5% for the rest of the year looks likely.
In the last few meetings, the MPC held growth as the overriding objective, and, now, there is more clarity on negative growth expected. RBI will probably have its growth outlook number this time, as evolving conditions have gotten clearer. The first quarter has been a disaster of mammoth proportions for the economy, and, while conditions will get only better, the question is whether the interest rate cut is important now.
RBI has aggressively induced liquidity in the system, which, ironically, is getting reinvested in the reverse repo auctions at around Rs 6 lakh crore a day. This signals that RBI may pitch to lower this rate further, from 3.35% to 3% or 3.1% to dissuade banks. The positive development is, as stated by the FM, the flow of funds to the SMEs has increased sharply till mid-July, and data for the fortnight ending July 3 reveals around Rs 48,000 crore of incremental credit. Thus, it is logical to conclude that the economic package announced by FM, which includes guarantee of credit to SMEs, has taken off.
The interesting thing is that this increase in credit to SMEs comes at a time when they are still finding it hard to get back on their feet, and economic activity is just about recovering. Therefore, it does look like that the first round of credit flow would be more for sustenance rather than growth as this segment has been impacted by cessation of activity and a high level of receivables from the linked production. The second round of credit would probably be more for growth, and, hopefully, should be before the guarantee scheme ends in October 2020.
In terms of lending rates, the MCLR has moved down to 6.65-7.3%. At this juncture, it should be kept in mind that a large set of borrowers have used the moratorium allowed by RBI; this is primarily to tide over times when there is less revenue due to the lockdown. Lowering rates further would help, albeit again as relief. But, large-scale borrowing at such low rates could lead to mis-pricing in the market and result in higher leverage at a time when economic activity has not yet picked up. Therefore, there is a counter-argument for keeping rates unchanged for the time being and wait for the revival to take place. Theoretically, lowering rates when the economy is on the upward slope is more risk-compliant than when conditions are really downbeat.
A related issue that will definitely be deliberated in the context of banking is the moratorium, as the concept came as part of the policy in March, and again in May. At present, the moratorium is for 6 months, and at some stage, it will have to be rolled back. As has been seen even in the case of ‘unlocking’ over the last two months, there has been volatility with ground-level disturbances. Therefore, the central bank needs to have a plan in place as to how the system can be moved away from the moratorium and be brought back to normal. The definition of NPAs, too, would have to go back to normal as these two concepts run in parallel.
This is where RBI needs to have a roadmap defined for banks. Some of the scenarios that can be conjectured here are the following. First, the moratorium may have to be extended; we are in the second quarter of the financial year, and most firms are still operating at low capacity utilisation levels while some in services are barely operational. Therefore, an extension by another quarter or even a month or two can be considered. Second, there is a possibility that, based on the advice of the government, there can be a restructuring of certain loans. While those for SMEs are almost a given for inclusion if this happens, other categories, too, may be considered over time. Hence, a roadmap for the same is something that maybe expected in the policy statement.
As the economy is progressing in the right direction, even though the pace may be equivalent to a crawl, the market expectation is that there should be sectoral TLTROs. This will be of use to sectors that require funding for both survival and growth. Real estate, auto, hospitality, aviation, etc, are segments which would be looking for some support through the monetary system. The upcoming credit policy will be the first official policy since the economic relief package was announced in the last week of May. There has been time to take stock of earlier measures like liquidity, lower repo and reverse repo rates and TLTROs. Such a wish-list is hence not out of place.
There will be a lot of expectation from the credit policy this time, not restricted to just the repo rate. The policy measures beyond the development measures, which are normally put on the table, will be important.
The author is Chief economist, CARE Ratings
Views are personal