The MPC is in a tight spot. It cannot cut rates at this stage when the retail inflation continues to be high. At the same time, ignoring signs of a deepening growth contraction will be a mistake
This week’s big event in banking is the monetary policy announcement. The monetary policy committee (MPC), which is the rate-setting panel of the Reserve Bank of India (RBI), will announce its decision later this week. The three-day meeting –from September 29 to October 1—comes at a time when inflation has consistently stayed above the central bank’s comfort zone and the economy has contracted steeply.
It is fairly certain that the MPC, which has repeatedly cautioned about inflation risks, will keep the policy rate on hold. It could retain the “accommodative” policy stance to give an assurance to financial markets that the panel is sensitive to the equally worrying growth scenario.
Since February 2019, the MPC has cut the repo rate, the rate at which the RBI lends to banks, by a steep 250 basis points. One bps is one-hundredth of a percentage point.
According to Barclays, in response to a 250bps reduction in the repo rate since February 2019, one-year government yields are now 300bps lower, band borrowing costs for highly-rated corporates are 309 bps lower.
However, the desired result—lower borrowing cost leading to a big revival in bank credit—has not happened. The credit flow to most sectors remains muted. The reason isn’t hard to understand; in a devastating economic growth scenario, there is not enough demand for bank credit. Companies are putting off projects; even ongoing projects are on hold.
Consumer confidence is low in the backdrop of huge job losses, salary cuts and uncertainty about the economic future. Discretionary spending on goods and services is absent. Except some government spending, there is no real investment activity on the ground. Bank credit is required only when there is an underlying demand in the economy.
At the macro level, the entire problem can be attributed to gross uncertainty about the coronavirus outbreak that is showing no signs of abating. New infections are spreading at a faster clip, triggering fears of another round of lockdowns that can derail nascent recovery.
The inflation trend is worrying. In August, India's retail inflation stood at 6.69 percent, according to data released by the National Statistical Office (NSO) on September 14.
The consumer price index (CPI)-based inflation rate for July has been revised to 6.73 percent from 6.93 percent. This is the fifth month in a row that retail inflation has stayed above the RBI’s comfort level at the upper band of 6 percent.
The MPC has some tough decisions to make. While a status quo on policy rates is almost a given, what needs to be watched is the growth projection from the central bank. Since February 2020, the RBI has not given a solid economic projection. The bank’s view on growth is important to understand its likely response to the monetary policy front.
To help the pandemic-battered economy, the RBI has gone far beyond conventional policy tools. It has announced several liquidity-easing measures, a six-month moratorium on term loans and a one-time loan restructuring scheme that will effectively push the moratorium for up to two years.
The central bank’s response to Covid-19 has been timely and effective compared with the inadequate response from fiscal authorities.
The MPC will likely be cautious about its growth forecast while keeping the key policy rate unchanged and retaining an “accommodative stance” for now.(Banking Central is a weekly column that keeps a close watch and connects the dots about the sector's most important events for readers.)