There is near unanimity amongst forecasters over the likely decision of the RBI on policy rates. The overwhelming consensus on any issue involving human intervention is always bewildering, but consensus on economic issues is even more perturbing as it is against the basic concept of the market. It is like a stock that has only buyers or only sellers on all days.
The Monetary Policy Committee (MPC) of the RBI is presently faced with unprecedented complexities in policymaking. The global economy is witnessing a slowdown that threatens to be protracting and deflationary. The global growth this time has retreated from the lowest peak in many decades. The intensity of deflationary pressure could be gauged from the fact that despite unprecedented liquidity infusion and negative interest rates, both ECB and BoJ have failed in achieving their inflation targets for almost a decade now.
In a world struggling with deflationary pressures and slowing growth, MPC might end up spending a significant amount of time bothering about the onion prices and fiscal pressures due to tax rate cut and a shortfall in GST collections.
Besides, the MPC is faced with the unenviable task of maintaining the competitiveness of Indian rupee to protect exports; need to augment US dollar reserves to protect the economy against a possible BoP crisis, protecting the interests of importers and borrowers in foreign currency, and at the same time keeping real rates supportive for domestic savings which have been on the decline since past one decade.
RBI Governor Shaktikanta Das has asserted on more than one occasion that there is adequate liquidity in the system and banks are in a position to cut rates without any change in the policy rates. However, by maintaining the interest rates on EPF, the government has given a confused signal on the trajectory of rates it wants. Given the fiscal constraints and need to create investment demand, bringing down the real rate to neutral or even marginally negative territory is desirable. Pushing inflation higher may not be a viable method of attaining this goal. So the rates need to be cut drastically to make the real rates neutral.
Rate cut needs to be dramatic
In my view, the economic viability of a nominal rate cut is arguable at this point in time. The rate cut is needed presently more from the sentiment viewpoint rather than anything else. Therefore it has to be dramatic with a ‘whatever it takes’ promise to have any meaningful impact on the economy. We have seen the government and the RBI wasting too many scarce bullets, without an aim. It must be recognised that we are running desperately short of time and tools for tackling the economic slowdown. The fiscal space is almost exhausted.
Remember, mere rate cuts are not necessarily positive for the economy and markets. The policy-driven change in interest rates has in the past impacted the domestic currency rate. On many occasions interest rate cut by the RBI have been followed by depreciation in Indian rupee. As per various research studies, over half of the BSE500 constituents, which account for 70 percent of the balance sheet debt, have historically suffered a 1.3 percent EBITDA (by value) erosion for a 1 percent rupee depreciation. The benefit of a lower interest rate is thus often muted, and in some cases, the impact on credit metrics such as coverage ratio is actually negative.
Under the scenario of a 25-35 bps interest rate cut followed by a 2 percent depreciation in the currency, the amount of stressed debt within BSE 500 corporates may increase materially.
In my view, therefore, the question before the RBI is not the simple one, i.e., ‘cut or not to cut’. It is rather complex, i.e., how to ensure rates that would support economic growth, improve the asset quality of banks and still be remunerative for savers.
I would like to see the RBI taking a strong definitive stand on supporting the growth by making a categorical and loud ‘whatever it takes’ statement. To make a meaningful impact on sentiments, it should cut rates by 75-100 bps. This should be followed by forcing the struggling private sector banks and NBFCs to immediately write down assets assuming the worst case, and yield control and merge their businesses with larger peers, just like the US Fed did with Merrill Lynch in 2008. The policy statement must omit any reference to inflation to make the growth focus unequivocal and unapologetic. I am sure we shall live for another day to bother about inflation and fiscal challenges.
Vijay Kumar Gaba explores the treasure you know as India, and shares his experiences and observations about social, economic and cultural events and conditions. He contributes his pennies to the society as Director, Equal India Foundation. Read his columns