Monetary Policy: Understanding The RBI’s Unusual Move
The apparent short-cycle policy normalisation by RBI could very well turn into a uniform rate-easing cycle across central banks.
On a day when central banks around the world decided to surprise the market with deeper and unanticipated rate cuts, India’s Monetary Policy Committee decided to cut the repo rate by 35 basis points to 5.4 percent and maintaining the accommodative stance.
We now believe that the apparent short-cycle of monetary policy normalisation as proposed by the RBI could very well turn into a uniform rate-easing cycle across emerging economies and global central banks. Surprisingly, 2019 seems to be worse than 2008 with external strife of trade wars now getting integrated with domestic growth weakness in emerging economies. In fact, 2008 witnessed non-synchronised rate cutting in contrast to the current synchronised actions! Mexico could join the bandwagon on Aug. 15 and thus make the list complete!
Precedent To Non-25 Basis Point Changes
From 6.50 percent in the December 2018 policy, the repo rate has now come down by 110 basis points. This is the first time such an unorthodox number of 35 basis points has been chosen. However, this is not something new.
China has experimented with rate changes that are not in multiples of 25 basis points, but it was abandoned in October 2010.
Only on two occasions after 2010 has the rate change by the People’s Bank of China not been in a multiple of 25 basis points. The European Central Bank too has changed rates in multiples lower than 25 basis points. ECB changes, however, may not be strictly comparable as these have been on an infintely smaller base. The U.S. Federal Reserve’s rate changes, though, are in multiples of 25 basis points. The advantages of a 25-basis-point construct, as believed, is the simplicity of connecting with the market.
Communication Key, With Such Asymmetric Moves
Even as RBI has cut rates, the markets await future guidance from the central bank in terms of quantum of cuts. This was perhaps reflected in government securities rates witnessing a mild spike post-policy.
Rate changes of an odd magnitude could be difficult to convey to the markets unless properly decoded, as it creates a a similar signal extraction problem. This exactly what transpired today.
We believe such unconventional policy changes should prod the RBI to use communication as a policy in itself rather than the policy statement being the vehicle for communication.
Rate Transmission Improving
Coming to transmission, the MPC believes that transmission has improved. The weighted-average lending rates on fresh rupee loans for scheduled commercial banks have now been reduced by 29 basis points between January and June 2019.
A study of bank-wise one-year MCLR shows that among the public sector banks, State Bank of India has reduced its MCLR by 30 basis points, followed by Allahabad Bank at 20 basis points.
While private sector banks have reduced rates anywhere between 44 basis points and 5 basis points, their overall level is higher than public sector banks.
We strongly believe that the RBI should now cajole banks towards external benchmarking. It may be noted that SBI is the only bank to have taken the lead in using repo rate on the asset side as an external benchmark, beginning May 1, 2019, and savings bank account on the liability side. We believe such an experiment can only be successful if all banks work in tandem. It may be noted that savings bank accounts are mostly used for transactional purposes and thus could be a win-win for both banks and customers.
Cross-Winds Galore
Inflation is expected to remain within the target over a 12-month ahead horizon. The RBI has projected CPI inflation for Q2FY20 at 3.1 percent, and 3.5-3.7 percent in H2FY20, against the earlier forecast of 3.4-3.7 percent. However, there are risks related to an uneven spatial and temporal distribution of the monsoon and oil price volatility owing to geopolitical tensions.
The growth slowdown has led RBI to cut its GDP growth forecast by 10 basis points to 6.9 percent (5.8-6.6 percent in H1FY20, and 7.3-7.5 in H2FY20).
Concern has been raised about external growth as well. On the global front, the geopolitical tensions in the Persian Gulf, the Korean Peninsula, and the South China Sea cloud the economic outlook of the Indo-Pacific region and particularly India. The latest escalation in the U.S.-China trade war, with China being labeled as a currency manipulator, will further increase the risks and adversely impact growth rates. Overall, the sentiment of the policy is tilted towards supporting growth as inflation conditions remain range-bound.
Growth Boosters
The policy has outlined a bazooka of measures to arrest growth slowdown.
- NBFCs have now been provided further leeway with RBI increasing an NBFC’s single counterparty exposure limit to 20 percent of Tier-1 capital of the bank, from 15 percent earlier, same as for other sectors.
- RBI has also allowed banks to lend to registered NBFCs for on-lending to agriculture, MSMEs, and up to specified limits to be classified as priority sector lending. These measures will help the liquidity situation of NBFCs.
- Another positive for the banking industry is the reduction in risk-weight for consumer credit. As the share of consumer credit outstanding (ex-credit cards) is 25 percent of gross bank credit, this reduction in risk weights will release a significant amount of capital for banks, of around Rs 22,000 crore.
Other measures like round-the-clock availability of NEFT, on-tap authorisation for retail payment systems and creation of a Central Payments Fraud Information Registry are aimed at building the digital infrastructure. Currently, the average volume of NEFT transaction is around Rs 19 lakh crore with 85 lakh average daily transactions. It may, however, be fit to consider if different payment interfaces, like RTGS, NEFT, IMPS, etc. which have different amount wise slabs, are also unified.
Soumya Kanti Ghosh is Group Chief Economic Advisor at State Bank of India. Views are personal.
The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.