For the second time, the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) has met before schedule and taken a decision to lower the repo rate. This time it is by 40 basis points (bps) and the signal is quite strong that it will do anything to restore growth; hence, one may expect more of such cuts going ahead. The reverse repo rate also comes down to 3.35 per cent, which is significant as it becomes even less attractive for banks to put surplus funds here.
It will be interesting to see how banks react. These have been challenging times for banks. Lending more to firms which are non-functional has higher credit risk. As a result, banks have been shying away so far despite the continuous nudging from the RBI. Also, given that the expected borrowing by the centre and state governments will be higher, there could still be incentive to wait for these securities to invest.
This becomes pertinent because all the norms of relaxation of payments in the form of moratorium on term loans and extension of working capital limits and margins would mean that will have to rework their business models. Therefore, the banking sector will witness substantial disruption in flow of funds as borrowers may defer their debt service payments and convert accrued interest to term loans.
The RBI has been quite conservative on the macro economic forecasts. For gross domestic product (GDP) growth, the central bank has acknowledged it will be in the negative, but has not put a number to it yet. The signal given here is that the second half looks better poised for growth to take-off in a limited manner with the farm sector showing the way. Yet, demand would be retarded due to the lockdown. But, two months of lockdown and a possible gradual opening up means that growth has moved into the negative territory for sure. This is different from the International Monetary Fund (IMF), which had put a positive number for India earlier in April.
On inflation, the RBI appears to be cautious though more optimistic. For the first half, it admits that inflation will be high due food prices going up quite sharply, with core inflation being measured. It has, however, pointed out that while demand side factors have been negligible, supply distortions have affected the movement of goods and hence there has been an upward pressure on prices. From the second half of the year, RBI expects that inflation will move down and sees the headline number being close to the target of 4 per cent during this period. Therefore, the first half would be one of caution as supply distortions in particular will skew prices.
Quite clearly, the RBI has taken the stance of doing everything to keep the economy going and has rolled over all the regulatory decisions taken in March and April, which was expected as the lockdown had a very negative impact on enterprise. The central bank has not opted for any new route of liquidity provision through targeted long-term refinance options (TLTROs) for sectors, which was expected post the FM’s announcements last week. That would have helped sectors like aviation, hotels, tourism, entertainment, auto etc. that have seen a set back sharply due to the shutdown. Banks will have more time to plan their books given these extensions and figure out how their asset quality would look like by March 2021.
Madan Sabnavis is chief economist at CARE Ratings. Views are personal.