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RBI’s 35 bps repo rate cut seems appropriate in current circumstances

Given the telltale signs of an economic slowdown, it came as no surprise when the MPC announced a repo rate cut on Wednesday. The surprise package was the shift away from ‘multiples of 25’. With the MPC having reduced rates by 75 basis points between February and June this year, and 110 including the latest move, the question is whether banks will follow suit. Banks have reduced their interest rates on fresh rupee loans by 29 basis points between February and June, thereby transmitting 40 per cent of the rate reduction. It remains to be seen whether there will be a trend shift in this respect, even if, as RBI Governor Shaktikanta Das claims, the NPA overhang has dissipated. There are many structural constraints at work. The first is the necessity to retain retail depositors, who are exploring other investment avenues. As a recent RBI paper ‘Financial stocks and flows in the Indian economy 2011-12 to 2017-18’ observes: “There has been a shift in savings of households sector from physical to financial assets. Furthermore, a shift away from bank deposits to investments in mutual funds, insurance and pension funds is also observed.” The SBI has cut deposit rates despite a falling trend in bank deposit growth, in order to be able to reduce its lending rates, but this trend does not appear sustainable. It has already dipped into its high reserves of G-Secs, in the process bringing down the SLR, leaving it little elbow room to carry on. Public sector banks remain risk averse due to the managerial ecosystem they inhabit. Despite policy exhortations, the option of borrowing from the repo window and investing in G-Secs (nearly 100 basis points higher) will remain an attractive one.

The recent increase in credit disbursed by banks from 10 per cent in 2017-18 to 13.3 per cent in 2018-19 reflects a shift in loan market share from NBFCs after the IL&FS meltdown, and not an overall increase in credit demand. The MPC has, following up on the Budget, focussed on pushing liquidity into NBFCs, in order to revive the housing and consumer durables sectors, where their presence is significant. However, it is also a fact that high-rated NBFCs have been able to source funds at pre-IL&FS crisis rates, implying that the market is merely rewarding good corporate governance. Therefore, it’s also a question of banks adapting to a dynamic, differentiated financial market.

A 35 basis point cut was well considered, given benign inflation, the urgency to restore growth and the imperative of keeping the currency markets stable. A cut of, say, 50 basis points may have created conditions for FPI outflows at a time when trade skirmishes the world over have roiled currencies. However, monetary accommodation alone may not help in perking up growth. The government must step up its act on the capex front.

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