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From Neutral To Accommodative

Will the change in RBI’s monetary policy stance help boost growth?

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By Manika Gupta

A fter her first  Union Budget, which almost remained a non-event in terms of any reforms, Finance Minister Nirmala Sitharaman has gone on to introduce different policy decisions over the past couple of weeks, with the major one being the reduction of the corporate tax rate. Such announcements were frequent in nature and also referred to as budget-on-instalments on a lighter note.

The Reserve Bank of India under Governor Shaktikanta Das also switched its stance from neutral to accommodative. In common parlance, accommodative stance is taken when a central bank (such as RBI) attempts to expand the overall money supply to boost the economy when growth is slowing (as measured by GDP). The policy is implemented to allow the money supply to rise in line with national income and the demand for money.

Under the governorship of Das, the Reserve Bank of India delivered more rate cuts than ever in the past. This was, indeed, unprecedented.

“Effectively, the rate cut has been 100 basis points if you take into account the change in stance,” Das said. And the latest bi-monthly review on October 4, by the six-member Monetary Policy Committee (MPC) headed by Das, slashed the short-term lending rate, repo rate, by 25 basis points. This was the fifth consecutive rate cut effected by the Das-led monetary policy panel, and it was in addition to a cumulative 110 basis points rate cut that RBI has announced so far this year. The repo rate now stands at 5.15 per cent, the lowest since March 2010.

Is it growth-oriented?
It is noteworthy that the RBI has been the most aggressive central bank in Asia this year to ease policy and support growth amid low inflation. A gloomy global outlook fanned by trade tensions has since prompted policymakers from Australia to South Korea to be dovish in their rate cut. The expectations were that with these rate cuts, the latest being 25 bps, there will be a boost to consumption and it will incentivise consumption. As Mayank Jalan, President, Indian Chamber of Commerce said that the reduction in rates will bring down the lending rates and hence provide the much needed liquidity in the economy. Jalan added that it will also incentivise investment and boost consumption.

But is that happening? The answer is no. The rate cuts have failed to have any impact on the economy which is constantly in a slowdown mode. The question is: will this accommodative monetary stance help in kickstarting growth?

Most agree that it is a short-term solution. It is at best a necessary condition, not magic bullet to kill the slowdown. While according to some economists, the quantum of rate cuts is not enough and more rate cuts are needed to kick-start the economy, others feel that the accommodative stance is fine but the effect of it should have been allowed to filter down to the economy. In fact, many feel that even a 75 basis point cut was enough of a stimulus for the economy and it should be allowed to filter down the real economy before more easing is  effected.

Rajeev Radhakrish-nan, Head of Fixed Income and Fund Manager of SBI Mutual Fund said that even as macro challenges facing the economy cannot be addressed by monetary policy alone, given the extant growth — inflation outlook and cyclical/structural factors impacting growth, the current easing phase can sustain for a while even as liquidity conditions may remain conducive for rates transmission.

The equity way
It appears that the rate cut even failed to boost the market sentiment as the equity benchmarks Sensex and Nifty fell after the central bank announced a rate cut of 25 basis points. Sensex plunged 407 points intraday and Nifty fell below 11,200 with most rate-sensitive stocks in the red. Market observers said while the rate cut is a positive move, the market felt disappointed as it was short of expectations.

Milan Vaishnav, Gemstone Equity Research & Advisory Services’ Consultant Technical Analyst, is of the view that the failure of the series of rate cuts to bring the desired results has more substantial reasons behind it, which the government needs to address at the earliest. The recent corporate tax rate cut was appreciated by everyone as a bold step that the government has taken. However, this being said, it is important to note that the government is doing all it can do to take care of the supply side concerns; in the same breath, it has not taken any measures and failed to address the demand-side concerns. If we examine the steps taken in the recent past, none of them have been directed towards the revival of the slowing domestic demand.

Another reason for the rate cuts not having the desired outcome is that their transmission has been dismal. Out of the total rate reduction of 135 bps in 2019, hardly 29 bps has been passed on to the end consumers.

Usually, if a rate cut is transmitted fully to the borrower, it should make loans cheaper. However, as of now, the weighted average lending rate on new loans has just reduced by 30 bps. This leaves much space for measures that need to be taken in this area. The government should ensure maximum transmission of the reduced rates.

The banks, too, the way they are asked to encourage credit offtake, should also be told to fully pass on the rate cuts. However, with the clear signs of a slowdown in the economy, data showed that only 50 per cent of the private sector banks had reduced their MCLR until July after three successive rate cuts.

The government needs to take a serious note of the fact that India’s historically high inflation has been brought permanently under control and that calls for a demand-side stimulus to be pushed in. It is beyond doubt that the slowdown in growth is caused and driven by a sharp drop in the domestic demand.

The total public sector borrowings have reached 9 per cent of the GDP, and thus it consumes nearly all the household savings of the people. The excessive borrowings have also contributed enough to the rate cuts not being useful in the past. Along with the banks not passing on the rate cuts entirely, the government also leaves little for the private sector to borrow anyway.

The banks are reluctant to give up their margins following a slowdown, and this hinders the full transmission of the rate cuts. In order that all the fiscal measures have their desired effects, the government needs to now focus exclusively on demand stimulating measures; otherwise, the one-sided supply-side redressal of concerns will widen the fiscal deficit over the period.

Most of the economists feel that with so much reduction in interest rates it is now crucial that the transmission effect sets in quickly to kickstart new investments and business activity ahead of the festive season.

The need now is to ensure a revival in domestic demand, said Das while announcing RBI’s latest rate cuts, adding that an improving monsoon, lower oil prices and an easing of a domestic credit crunch were positive.

He said, “Waning consumption dragged gross domestic product growth to a five-year low of 5.8 per cent in the first three months of 2019, meaning India lost its title as the world’s fastest-growing major economy.”

That data was followed by the RBI in June lowering its growth forecast for the current fiscal year to 7 per cent from April’s projection of 7.2 per cent.

Das said, “I would not like to specify how long it will last”, referring to the current slowdown, although he specified that India is today in a far better place than most of the major economies and India has certain inherent resilience and the signs are looking good.

Vaishnav is also of the opinion that the government needs to take steps in the direction of revival of demand and initiate measures that will leave end consumers with some money in their hand to spend. Public investments are witnessing a delay, and the government funds are not being released to them on time. The government will have to pump funds into these projects to revive a chain of economic activities. At the same time, it needs to actively look towards the reduction of individual tax rates and tax on goods as well. These steps will put some liquidity in the hands of the end consumer.

The governor also said the central bank alone cannot boost the economy and there’s a need for more reforms with various stakeholders having a role to play in addressing the slowdown.
There is a need for structural reforms:  Das admitted that rate cuts were a necessity but the country needs structural reforms—an enabling business environment and measures to improve supply chains in the farm sector to make the economy more competitive.  


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