Structural impediments to domestic and foreign investment, including a falling savings rate, may negate its impact
It is somewhat strange that the third straight policy repo rate cut, the first time this has ever happened in RBI history, caused anything but euphoria in the markets, though the cut did match market expectations. The reason is plain to see — there was more to be worried about in the reports on the imminent collapse of an NBFC and less optimism on what a rate cut of 25 basis points (bps) could do in the circumstances. It is equally interesting to note that the RBI Governor had little to say on the subject though there are reports of a government probe into the matter.
But this is just one aspect of the disconnect between numbers on a page and the action that they can drive when six experts, including the Governor, sit down to take a view on the monetary policy.
There are, of course, a host of ancillary issues that impact monetary policy. Leaving those aside, one critical question that comes up is this: Will the rate cut lead to a greater off-take of loans in the given circumstances, leading to more investment activity that can drive our sagging growth numbers?
The answer has to be a plain ‘no’ because the economic system right now is caught in a series of challenges that cannot be addressed by short term quick fixes like the 25 bps cut. An accommodative policy stance can put more downward pressure on the rates but cannot drive investments though it certainly will smoothen the process of lending and borrowing.
Officially, the MPC is mandated to “maintain price stability keeping in mind growth.” Inflation is down. Growth is weak. The two together suggest a rate cut and this is what the MPC delivered. But, in the process, there is many a slip between the cup and the lip.
The approach that argues that rate action must follow a lower inflation number to revive growth is text bookish, a mechanical reading that is not sustainable because of other dynamics at play. One of the critical dynamics is the monetary policy transmission to the real sector and the capacity of the banking system and the investing community to absorb and sustain a higher level of investment activity at lower rates.
The last two policies delivered a cumulative 50 bps cut. In response, the RBI says, the weighted average lending rate (WALR) on fresh loans declined by 21 bps, with the lag of four to six months coming down now to two to three months.
The RBI data need not be questioned, but one still wonders how banks beset with so many structural challenges including massive NPAs have yielded to the rate reduction. This brings the apprehension of “arm-twisting” by the RBI and the government as regulator and owner rather than a market reaction.
Secondly, base rate and Marginal Cost Lending Rate (MCLR) vis-a-vis the policy repo rate data published in the weekly statistical supplement do not reveal any reduction in the rates.
Let it not be forgotten that investment in the economy critically depends on savings of the economy. According to available data, the savings rate (ratio of total savings to GDP) has been declining continuously from 34.7 per cent in 2011-12 to about 30 per cent in 2017-18.
The persistence of revenue deficit which conceptually is the dis-savings of the government at more than 2 per cent of GDP at the general government level (Central plus States) is a matter of serious concern as it is a drag on the total domestic savings of the economy. Besides, there is some evidence of preference for physical savings in terms of gold and real estate.
It is claimed by some that the public expenditure has elements of crowding-in. However, a large fiscal deficit (higher than 6 per cent of GDP for both Centre and the States together) implies higher borrowings from the market and perforce results in crowding out of private investment. In this scenario, how will the interest rate reduction help?
Apart from the concerns over the domestic private investment, there is concern regarding foreign direct investment (FDI).
The net FDI flow has been showing a declining trend from around $36 billion in 2015-16 to $30.3 billion in 2017-18.
Besides, as the MPC resolution itself admits, investment activity may be adversely impacted by the weak global demand and escalation of trade wars (mainly through lower export demand).
Thus, given the structural impediments to domestic and foreign investment, the question that remains is to what extent an interest rate reduction will be helpful in this situation.
The writer is a former central banker and a faculty member at SPJIMR. (Through The Billion Press)