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Why RBI policy is now a non-event for the common man

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A closer look at the minutes of the monetary policy committee (MPC) released on Friday shows deepening worries among the members about the lack of monetary policy transmission in the banking system, which makes the monetary policy ineffective.

“For monetary policy actions to transmit fully to the credit market, it is important that banks remain well capitalised. Only banks with strong balance sheets could be expected to support lending activity as and when credit demand picks up,” said Janak Raj, one of the MPC panel members.

India’s banking system is dominated by state-run banks which control 60 percent of the assets. Government, the majority stakeholder in these banks, has not allocated any capital this fiscal year for these banks. Banks require capital mainly for two reasons.

To set aside money against risky loans (provisions) and to lend afresh. Chetan Ghate, another MPC member, too has clearly said that rate cuts do not work unless banks restart lending.

“For rate cuts to work, banks have to lend. Despite the large number of steps taken to improve the liquidity and functioning of credit markets, as of April 24 (the most recent data available), non-food credit growth on a y-o-y basis was at 6.5 percent on May 8, 2020, lower than 7.2 per cent on April 10, 2020,” Ghate said.

In effect, the MPC members have sent a clear signal to the government on the recapitalisation issue of PSBs.

Capital is not the only worry. Lack of demand on the ground is a bigger problem. Companies do not have the confidence to borrow more in a scenario where consumer demand is low.

The recent RBI consumer surveys point to a sharp fall in consumer sentiments. How can the demand situation improve? Monetary policy has only limited tools available to address the demand problem. Economists, for long, have pointed out that fiscal measures should be aimed at demand creation on the ground. This is absent so far.

Warning on growth situation

Lack of monetary transmission is a bigger worry in the context of sharp slowdown in economic growth. The RBI top brass has used strong words to describe the growth situation. For instance, governor Shaktikanta Das said the growth outlook has deteriorated sharply.

“Economic activity, however, is expected to contract in the first half of the year before recovering gradually in the second half of 2020-21 on the back of various fiscal, monetary and liquidity measures undertaken in the recent period,” said Das.

“Overall, the GDP growth in 2020-21 is estimated to remain in negative territory. The pace of recovery will be contingent upon the containment of the pandemic and how quickly social distancing/lockdown measures are phased out,” Das said.

Overall, this is the second statement from the governor on likely contraction in the economic growth due to Covid-19. In his last monetary policy statement Das first suggested that growth is likely to remain negative this year. “Given all these uncertainties, GDP growth in 2020-21 is estimated to remain in negative territory, with some pick-up in growth impulses from H2: 2020-21 onwards,” Das said.

Das committed an accommodative policy going ahead. “I also vote for persevering with the accommodative stance of monetary policy,” the governor said. Not just Das, his deputy Michael Patra too have flagged major threats to growth on account of pandemic.

Patra, who is in charge of monetary policy at the central bank, said: “My view is that the damage is so deep and extensive that India’s potential output has been pushed down, and it will take years to repair,” Patra said.

“The MPC has decided to remain accommodative as long as it is necessary to revive growth and mitigate the fallout of COVID-19.,” Patra said.

The MPC has reassured the government that it is willing to cut rates further if the situation warrants. But for these rate cuts to reflect on the ground, government needs to make sure banks are well capitalised. According to a BofA Securities report, Government-owned banks’ non-performing assets (NPA) could go up by 2-4 percent of the credit in the present economic environment. This, BofA says, will result in a recapitalisation requirement of $7-15 billion (Rs 1.14 lakh crore at the upper end).

How can a cash-starved government fund these banks? With revenues falling short of expectations and disinvestment not happening, the government is already walking a tight rope on fiscal discipline (expected around 5.5 percent this year).

The decision to borrow Rs 4.2 lakh crore additional itself was part of an emergency measure to cover the likely revenue losses. But PSB’s capital requirement cannot be ignored whether it happens through recap bonds or, as BofA suggests, by tapping RBI’s revaluation reserves.

If banks are reluctant to pass on the rate cuts to the end borrower, monetary policy actions, no matter how big is the quantum of the rate cut, do not have much impact. Till banks start lending,  RBI policy is a non-event for common man.