The RBI has spoken, now for the government

The Reserve Bank of India’s (RBI) June 6 monetary policy committee (MPC) meeting did not disappoint anyone. The six-member team ticked all the right boxes by agreeing to cut the repo rate—the rate at which the RBI lends to banks—by 25 basis points, changed their stance from “neutral” to “accommodative” – meaning no rate hikes in the near future. It also promised to keep the liquidity tap open for the non-banking financial companies (NBFC) and housing finance companies (HFC). Interestingly enough, the RBI has already ensured excess liquidity in the system from June 1.

It also took note of the slowdown in the economy by reducing the GDP growth rate from 7.2% to 7% and expressed fears of reduced exports and global investments because of the escalation in trade wars. No wonder, the report maintains that that there is scope “for the MPC to accommodate growth concerns by supporting efforts to boost aggregate demand, and in particular reinvigorate private investment activity while remaining consistent with its flexible inflation targeting mandate.”

The MPC also expressed unhappiness at the slow pace of rate cut transmission by the banks arguing that the average lending rate has gone down by only 0.21 % as against the policy rate cut of 0.50%. More importantly, the rate on older loans had increased by 0.04% while the repo rate had come down by 50 basis points in the past two years. V S Parthasarathy, group CFO, Mahindra points out:  “While the rate cut and the stance is good, the transmission and execution will make it great and help the country to Rise.”

Rajnish Kumar, chairman, State Bank of India, says, “The RBI policy decision to change the policy stance to “accommodative” will simultaneously help the financial system to navigate to a lower term structure of interest rates and also accommodate growth concerns. On the regulatory front, the decision to lower the Basel III leverage ratio from-- 4.5% to 3.5%-- will augment the lendable resources of the banks.”

However, lowering interest rates by the banks is easier said than done. As long as the government continues to pay 8% interest rate on small-scale savings like post office saving accounts, banks will find it difficult to reduce interest rates because they will be starved of deposits. Moreover, there has been little transmission because of the asset quality pains of state-owned lenders.

While not mentioning the recent crisis in the NBFCs and HFCs, the RBI governor promised to closely monitor the developments in this sector to ensure financial stability and also set up an internal working group to review the existing liquidity framework for the system, which is expected to finalise its report by July.

Other policy changes by the RBI governor Shaktikanta Das includes waiving charges on real time gross settlement system( RTGS) and national electronics fund transfer (NEFT) to push digital transactions, a panel to review ATM charges—the fees levied by banks. It would soon issue draft guidelines for “on tap” licensing of small finance banks by August this year.

However, an accommodative monetary policy can only do so much, but it is no silver bullet and a lot of initiatives will be needed from the finance ministry to put the economy back on track. The financial sector requires large scale reforms to set it right and not just excess. The real crisis in the non-banking companies and housing finance companies is not about liquidity, but about a crisis of confidence regarding the players and functioning of the system itself. Banks, mutual funds and insurance companies are refusing to lend to the NBFCs and HFCs after the meltdown of the Infrastructure Leasing & Financing Company.  They have become risk averse not knowing which company will default next.

And with the Dewan Housing Finance Company (DHFL) missing its repayment deadline on a set of convertible debentures and likely to default on ₹750 crore of commercial paper on Friday, the situation is going to go from bad to worse. With the credit rating agencies like ICRA and CRISIL sharply downgrading the company’s papers, any chance of raising funds from the market too has dried up. And no amount of liquidity injection will help.

The finance ministry therefore needs to step in and restore confidence in the shadow banking  sector. They can do so either by ensuring that NBFCs do not “borrow short and lend long” and prevent them from taking other excessive risks. The government needs to find new financing models or more sustainable form of funding for NBFCs, and also look closely at the issue of whether there is a need for a separate regulator to monitor the day-to-day functioning of the NBFCs. Otherwise, the country will never rid itself from cases of NBFCs defaulting on their payments on a regular basis.

Bringing down real interest rates is only one of the many ways to fire up the spirit of the Indian corporate sector. But there are a host of other factors that determine their willingness to invest in greenfield projects and make necessary investments. But failing consumption demand both in the urban and rural sector, falling wages, a high unemployment rate, the worst in 45 years and an adverse external environment is unlikely to lure India Inc. to invest. Here too the finance ministry needs to step in by accelerating the implementation of the Pradhan Mantri Kissan Samman Nidhi— ₹6,000 in the hands of all the farmers in the country and reduce income tax slabs in the July 6 Budget and take more steps to put more money in the hands of the people to boost immediate consumption.

So unless the two—the RBI and the finance ministry—work in tandem, one complementing the other, it won’t be easy to get the economy moving again.