Rate Cut For Sure: Now Or In August? And, How Much? 25, 50 or 35 BPS?


Last Friday, hours after India got its newest finance minister Nirmala Sitharaman, a ministry of statistics and programme implementation release revealed that India is no longer the world’s fastest growing large economy. The economic growth in the last quarter of 2019, ending March, dropped to 5.8 per cent, the lowest in the past 20 quarters. This also pulled down the annual growth in India’s gross domestic product (GDP) to 6.8 per cent, the slowest in the Modi 1.0 regime.

To add to the woes, the first periodic labour force survey of the government, released on the same day, showed the unemployment rate at a 45-year high of 6.1 per cent in 2017-18 (July-June).

What will the two-monetary policy old Reserve Bank of India (RBI) governor Shaktikanta Das do on June 6? Will he go for yet another rate cut?

Of course, it’s no longer a governor’s policy. An independent monetary policy committee (MPC) will deliberate on this but Das, who heads the six-member panel, has a critical role to play and he makes no bones about his bias for growth. In the past two MPC meetings in February and April, the policy rate was cut by 25 basis points (bps) each, to 6 per cent. One bps is a hundredth of a percentage point. Should we see it coming down to 5.75 per cent or even 5.5 per cent? 

Or, say, even 5.65 per cent as Das, at the recent IMF-World Bank spring meeting, made it clear that he does not believe that the unit of 25 bps is sacrosanct — it’s just a convention; it could be 10 or 35 bps, tailored to suit the dynamics of the economic situation.

There are, of course, reasons why the MPC should hold its horses and wait for its next meeting in August by when the Union Budget will be presented (it’s on July 5) and we will get a clear sense of the fiscal deficit estimates of the current financial year. In 2019, the fiscal deficit was 3.39 per cent of GDP, well within the revised estimate of 3.4 per cent. Also, the trajectory of the monsoon will be clear by that time. India’s weather office has predicted a normal monsoon.

Most importantly, the effect of the past two rate cuts has not been seen as yet. In other words, monetary transmission is not happening. Going by data, in the January-May 2019 period, we have seen the weakest transmission in recent times. Taking the loan rate of State Bank of India, the nation’s largest lender, as benchmark, the transmission is just 20 per cent (50 bps policy rate cut versus 10 bps loan rate cut). In the April-December 2018 period, when the policy rate was hiked by 50 bps, the transmission was 70 per cent. Between December 2016 and March 2018, when the policy rate was cut by 25 bps, the transmission was 300 per cent! This is because of demonitisation which flooded the system with liquidity.

More than the policy rate, liquidity is the key to monetary transmission. And, the RBI must address this. To be fair to the central bank, it is sensitive to the liquidity conundrum. It has generated around Rs 70,000 crore through a new tool of dollar-rupee swap through two $5 billion such buy/sell swap auctions in March and April. Besides, Rs 25,000 crore has been pumped in through bond buying under the so-called open market operations (OMO) and another Rs 12,500 crore OMO is slated after the policy meeting.

As a result of all these, the 10-year bond yield dropped to 7.03 per cent on Friday, its 18-month low. Of course, expectations of a rate cut and the drop in crude oil prices to $64.97 a barrel contributed to this. Incidentally, the 10-year US Treasury yield too declined sharply last week to its lowest level since September 2017. Since the rate cut in February, the 10-year yield of Indian bond dropped almost 50 bps.The difference between the policy rate and the bond yield is now 100 bps, close to its long-term average (from April 2001 till date) of 90 bps.

Clearly, monetary transmission is happening in the bond market but not in the loan market. The average liquidity deficit, which was little over Rs 70,000 crore in April, dropped to Rs 37,600 crore in May. It is expected to turn surplus in June and may continue in that mode till August, driven by OMOs and RBI dividend to be paid to the government.

But even then there is no guarantee that banks will bring down their rates and start giving loans. They have developed risk aversion because of the state of affairs in the non-banking finance industry where many companies are suffering from acute asset-liability mismatches; they are starved of liquidity.

To address this, the RBI last week tweaked the securitisation norms for the NBFCs and extended the period of “dispensation”. Such companies are now permitted to securitise loans of at least five-year maturity after holding them for six months on their books. In November 2018, when RBI first permitted this, it had kept the holding period for at least a year. And, the dispensation which was to be valid till May, has been extended now to December. The relaxation in minimum holding period will particularly benefit the housing finance companies as the tenure of mortgage loans is typically more than five years. They can raise more funds through the securitisation route.

For the policy, the RBI has two choices before it.

Fist, holding on till August but making a clear statement that it will ensure surplus liquidity in the system through all tools available to it. This has to be accompanied by a change the stance of the policy, from neutral to accommodative.

Second, instead of waiting for the Budget, the trajectory of the monsoon and monetary transmission, the RBI could frontload both rate cut and liquidity injection. It can be done as even though the retail inflation inched up marginally to 2.9 per cent in April, the so-called core or non-food, non-oil manufacturing inflation fell sharply. The March index of industrial production was disappointing – contracting for the third successive month and falling 0.1 per cent year-on-year. There are enough indications of a broad-based slowdown. Since inflation is well within the 4 per cent (with a 2 per cent bad on either side) target of the MPC, I will not be surprised if the RBI goes for a rate cut now and not wait till August.

Will it be 35 bps, Mr Das?

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