Despite the continuing rate cuts, it had a little impact on the growth, as there has been little recovery in the economy during this period.
In its latest Monetary Policy Committee (MPC) meeting on December 5, the Reserve Bank of India kept key rates unchanged at 5.15 per cent (lowest in nine years, after five straight cuts with a cumulative 135 bps reduction this calendar year, to boost the country’s sagging economy.
RBI retained its 'accommodative' policy stance, which suggests that this is a pause rather than an end to the loosening cycle, and it still has room for a rate cut. Core inflation, which excludes energy and food items, slid beyond a seven-year low of 3.47 per cent, which clearly indicates that there is hardly any demand for non-food items in the market.
Usually, a rate cut helps revive economic growth as it allows retail customers to avail cheaper loans and works like a big booster for the large industrial sector, who will be able to avail bulk loans at lower interest rates.
Despite the continuing rate cuts, it had a little impact on growth as there has been little recovery in the economy during this period. India’s GDP growth in the July-September quarter of 2019-20 slowed to a 26-quarter low of 4.5 per cent.
So, why has the RBI’s rate cut failed to put the brakes on a declining economy?
Among others, some of the major causes are as below:
- Inadequate transmission of rate cut seen as a major hurdle in growth revival:
Despite a 135 basis points rate cut, new loans saw the transmission of only 44 basis points so far this year. Apart from this old borrowers have not benefited, RBI shows that borrowing cost for old borrowers rose 7 basis points despite four successive rate cuts of 110 bps between February and September.
Banks are gradually linking their loans to the repo rate, but given the flexibility to charge a spread/mark-up, considering other costs, the final lending rates are yet to come down in a commensurate manner.
The inadequate transmission is essentially hindering the desired economic growth as the rate cuts still unable to get fully transmitted by the banks to the end consumers, in the form of cheaper credit. Unless transmission happens, the rate cut will not result in GDP growth.
- In a push to curb rising non-performing assets (NPAs) and amid liquidity crisis, financial institutions became more restrictive on lending:
While private consumption decelerated to 4.1 per cent in H1FY20, retail lending of banks grew 16.6 per cent, which is twice the rate at which overall bank credit is growing. However, there is a catch.
According to CRISIL, a large chunk of the incremental retail loans disbursed by banks was used to buy retail loan portfolios of non-banking financial companies (NBFCs), which are struggling for over a year to raise funds.
Therefore, excluding loans disbursed to buy off pooled assets of NBFCs, the growth in retail lending of banks is actually slower than it has ever been in the last five years.
The slowdown in retail credit growth reflects both macroeconomic challenges which have constrained loan demand, and fewer loan sanctions by banks because of risk aversion.
The most affected sectors are the auto and real estate, which are the major contributors to economic growth. Liquidity risk is increasing for real estate developers, as NBFCs including housing finance companies (HFCs) are shying away from lending to the sector.
Developers that rely on refinancing from NBFCs, particularly those with weak financial profiles have been affected the most. The availability of unencumbered assets among large developers may be of limited use, as NBFCs are looking to shed their already-high exposure to the sector, especially to large borrowers.
Now, the dichotomy is such that the ones who need money do not get it and the ones who are offered money do not need it.
- The present economic slowdown has been aggravated by a decline in consumption and not been driven by a glut on the supply side:
The ongoing agrarian distress and dismal income growth so far, coupled with subdued income growth expectations in urban areas, have considerably weakened consumption demand.
Even the festive season failed to revive it, and this was reflected in current data of non-food credit, auto sales and select fast-moving consumer goods.
Given the stress in the real estate and manufacturing sectors, capacity utilisation in the economy since FY14 hovered between 70-76 per cent — that seems to show why rate cut has not benefited India Inc.
India’s economic growth has moved from not just being a jobless regime but to being a ‘job-loss’ one. There have recently been major layoffs of mid-to-senior employees across companies, while informal labour forces have been struggling for employment during the past couple of years.
So, it is not the rate cut, but the real disposable income in the hands of consumers and job security that can provide more help to enhance the consumption demand.
The way out:
Although the government is working on various fiscal measures such as recapitalisation of public sector utilities, infrastructure expenditure, reducing corporate tax and so on, it has less scope to further stretch its expenditure side without enhancing the receipt side.
The government is likely to miss its fiscal deficit target for FY20 and the actual number could be anywhere between 3.5-3.8 per cent of GDP, as against the budgeted 3.3 per cent.
Rather than relying heavily on a single method to pull the country out of an economic crisis, it is essential to maintain a balance between various measures.
If five rate cuts have failed to prevent India's growth from slipping this year, it is highly unlikely that another rate cut would help revive growth. Cutting interest rate is crucial for reviving demand but the RBI and government first have to identify issues within the banking sector and rectify them.
Along with cheaper credit, the way out of this slowdown could be a revival in consumer sentiment, especially in terms of income enhancement. Within the fiscal limit, the government should loosen its strings and do a massive fiscal front-loading in the economy.
Sector-specific measures and increased government spending could be the quickest way to create jobs, generating demand and boost growth in the near term.
The Author is director of Wealth Discovery/EZ WealthDisclaimer: The views and investment tips expressed by investment experts on moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.Get access to India's fastest growing financial subscriptions service Moneycontrol Pro for as little as Rs 599 for first year. Use the code "GETPRO". Moneycontrol Pro offers you all the information you need for wealth creation including actionable investment ideas, independent research and insights & analysis For more information, check out the Moneycontrol website or mobile app.