Rate cut a palliative measure; cannot counter coronavirus pandemic impact

The Reserve Bank of India’s (RBI’s) decision not to lower the repo rate was in a way expected; and it would be interesting to see how the market reacts. Post the US Federal Reserve (US Fed) lowering rates, it was widely debated whether the RBI would lower rates before the next policy or wait for the formal occasion.

It may be pointed out that the decision of the US Fed to lower rates in the first phase did not quite move the markets. The latest move to bring the rate down to 0 – 0.25 per cent with a quantitative easing (QE) attached would also be watched carefully. The cut by Bank of England (BOE) or the European Central Bank’s (ECB’s) assurance of quantitative easing (QE), too, have not quite lifted sentiment.

The question is whether a rate cut will work in times like these? There are two ways of looking at this. The first is from the macro perspective where rate cuts are to spur investment, and hence growth. The earlier cuts of 135 basis points (bps) have not quite delivered since the problem in India is on the demand side. Hence, this rate cut, even if transmitted adequately will not change the course of the economy. Also, it cannot counter the effects of the virus or the spread of the same. This has been accepted in the global context, too.

The other view is from the point of view of being a palliative at the time when the economy could be moving towards a faster slowdown due to this epidemic. We have seen that several industries have been affected directly like tourism, hospitality, aviation. Those like pharma, auto, electronics where the supply chains have been impacted are also likely to confront challenges as the China problem has become a global one. Some firms in these industries could be impacted negatively in terms of sales coming down and their working capital cost-servicing being a burden. In such a case, the lower interest rate scenario will help to alleviate their travails. This could ease the pressure on banks in a way as the probability of potential non-performing assets (NPAs) come down.

The latter looks more likely the impact of this rate cut provided there is efficient transmission. The signal sent clearly is that the RBI is willing to do everything to lessen the pain of the virus attack to the extent that it is possible. It may be recollected that the RBI had actually used novel measures in the earlier policy to lower rates like the long-term refinance option (LTRO) and cash reserve ratio (CRR) exemption on certain loans (SMR and retail). That has worked to an extent to help the concerned segments though not really brought in a large amount of fresh lending. The same will be the case here where the benefits will flow and pain alleviated.

Lowering rates at this time also carry the risk of affecting deposits, as banks will have to rework their deposit rates considering that the lending rates have already been affected where they have been linked to benchmarks like the T-bills yields, which have been going down. To maintain profitability through steady net interest margins, banks will have to lower deposit rates, too, which can come in the way of savers. This is a conundrum that banks will face.

Rate cut, in my view, cannot stop the virus from playing out its course and have an impact on the global financial markets and economy.

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Disclaimer: Madan Sabnavis is chief economist at CARE Ratings. Views are personal.