India's rates too high, RBI lost a golden opportunity PDF Print E-mail
Monday, 08 April 2019 04:03
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Shobhana edit

Given how RBI’s inflation forecasts have been trimmed and its seemingly benign outlook on prices, it is surprising that the repo rate was not trimmed by 50 bps instead of just 25. RBI on Thursday trimmed its headline CPI inflation projection for H1FY20 to 2.9-3% from 3.2-3.4% and to 3.5-3.8% for H2FY20; for the year to March 2021, RBI sees inflation at 3.8-4.1%. To be sure, RBI has listed risk factors such as poor monsoons, possible rise in oil prices and fiscal slippage but that has been baked into the outlook. At this point, when the economy is struggling to grow at beyond 7%, and India’s high real rates of interest are a factor in keeping investment low, a 50 bps cut would have given corporate borrowers some relief; transmission, though, can take 4-6 quarters and yields have, in fact, risen after last week’s cut.

RBI has lowered the FY20 growth forecast to 7.2% from the previous estimate of 7.4% and could, therefore, have front-loaded the cut. Private sector investment is already very sluggish and while lower interest rates alone cannot reverse the trend, they could help at the margin. In fact, economists believe RBI’s growth expectations are optimistic given tighter financial conditions will continue to impact markets and slowing global growth.

The fiscal situation, however, is now a real reason for concern. This is partly because the government itself is borrowing heavily—gross borrowings of `7.2 lakh crore in FY20—but more so because of the extra-budgetary borrowings which were close to `1.75 lakh crore in FY19. The spate of loan waivers and chances of more to come would see state governments also adding to the supply of paper. Besides, the several cash transfer welfare schemes being rolled out could necessitate more borrowings. Despite a repo rate cut and chances of another 25 basis points cut in either June or August, the yield on the benchmark jumped 9 basis points on Thursday and rose again on Friday. If an expanding fisc is the reason for the central bank’s caution, it should have been reflected in the inflation forecasts.

While RBI did retain its neutral stance and did not change it to accommodative, as was widely expected, it also noted that the risks to its inflation forecasts were broadly balanced. Also, given how banks take their time to transmit the cut in the repo rate to customers, a 50 basis points cut would have helped speed up the process. Bank of Baroda, for instance, left its MCLR unchanged after a meeting on Friday. Banks have been loathe to lower loan rates because deposits are becoming harder to come by and, consequently, they are unable to trim interest rates on deposits. Lowering loan rates would mean taking a hit on their margins. A 50 basis points cut may have made it easier for them to cut rates.



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