By keeping repo rates unchanged, the Monetary Policy Committee (MPC) surprised market watchers who felt that with retail inflation ruling low and industrial production struggling, a cut was in order. There was also the growth impact of demonetisation to contend with, particularly on agriculture and the informal sector. A rate cut may have signalled banks to drop rates on fresh loans (based on marginal cost lending), more so to sectors hurt by the recent cash squeeze. There is also the argument that the MPC could have taken its chance now, before global headwinds in the form of higher oil prices and Fed rate hikes shut the window of opportunity. With the Budget doing a tightrope between growth promotion and fiscal consolidation, those who expected a pro-growth signal from the MPC may have been disappointed.
However, the situation is rather complex. A persuasive case against a rate cut is that it is irrelevant now — banks do not need the repo window since they are awash with funds and can lower rates in any case. (It is, of course, another matter that the Reserve Bank has kept mum on the deposits banks have received after November 8.) The policy review observes that the “Reserve Bank’s market operations have been in liquidity absorption mode in December, January and February”, as a result of which the weighted average call money rate averaged 18 basis points below the policy rate during December and January. The huge transfer of currency from the public to the banks has, in fact, resulted in lower rates on retail loans for housing and consumer goods. Yet, monetary transmission at least in critical production sectors remains weak, even as it has improved on the whole after November 8. Of the 175 basis points reduction in policy rates since January 2015 (from 8 per cent to 6.25 per cent at present), no more than 120 basis points on an average may have passed through to the final borrower, according to the RBI Governor. Bank lending to medium and small industry is shrinking, even as retail lending is expanding. This is despite the fact that MSMEs are the largest employers after agriculture. Retail lending, also rising on account of the Seventh Pay panel’s bonanza, cannot alone be expected to trigger a broad-based revival. Since the debt overhang on banks is largely the making of large companies, the MPC should address the aversion to lending to MSMEs. Efforts to enhance refinance to small units will not work in isolation of ecosystem concerns.
The MPC could well have said, in the context of inflation likely to pick up in the second half of 2017-18 to 4.5-5 per cent, that real returns to savers need to be considered. It expects a turnaround in rates worldwide (now zero or negative), and fears a reversal of portfolio flows in the event of reduced interest rates here. It appears that monetary policy cannot be expected to deliver much in 2017-18, in a post-Trump order. The onus lies on the government to create the right conditions for growth.