Monetary Policy Review: The Onus Is Now On Banks To Make Policy Measures Work

The economy that is undergoing a challenging phase needs urgent support for revival. Accordingly, the policy interventions of Reserve Bank of India (RBI) articulated in its third bi-monthly monetary policy is well geared to resuscitate the slowing economy.

It succinctly combined monetary and regulatory measures to hone the synergy of banks and non-banks to accelerate growth. Keeping the signs of weaknesses in the economy, RBI has already moderated its gross domestic product (GDP) outlook to 6.9 per cent expecting it to hover in the range of 5.8-6.6 per cent in the first half (H1) of 2019-20 fiscal and 7.3-7.5 for H2 with downside risks.

Inflation is also expected to be 3.1 per cent for the second quarter (Q2) of 2019-20 and 3.5-3.7 per cent for H2: 2019-2020 with upside risks.

The actual consumer price index (CPI) inflation though stood at 3.2 per cent in June; up from 3 per cent in April-May 2019, it is well within the comfort zone of RBI.

Since crude oil prices for the present are placid due to weakening demand and increase in non-OPEC (Organization of the Petroleum Exporting Countries) production, the immediate risk to inflation is benign. Moreover, despite dovish guidance of US — Fed hiking benchmark rates by 25 basis points, respite may come from likely foreign portfolio investment (FPI) tax relief.

1. The Strategic Shift

The unique feature of the current policy move is the repo rate cut of 35 basis points (bps) that herald a new shift in modulating the benchmark rates. The market players can a take a cue that the policy rate changes could henceforth be spread in bits and pieces precisely calibrated to the evolving macroeconomic dynamics in line with global best practices instead of waiting until the change could be packaged into doses of 25 bps.

Such dynamism in rate setting exercise is a thoughtful move to effectively tackle the growing market volatility, geopolitical tensions and global trade tiff fast impacting financial markets.

Given the cumulative repo rate cut of 110 bps in the present interest rate cycle (since February), enough space is built for banks to cut lending rates.

Moreover, the neutral stance of the policy opens up scope for further rate cuts in near term if warranted. State Bank of India (SBI) leading the initiative has already cut its marginal cost of funds based lending rate (MCLR) by 15 bps bringing it down to 8.25 per cent.

Banks having passed on only 29 basis points so far will be hastening the transmission of lower interest rates to the economy.

The back-to-back reduction of repo rates and consistent benign inflation trajectory sets a better growth sentiment. But more significant will be to ensure hefty rise in incremental credit disbursement to industry at large with prime focus on sagging micro, small and medium enterprises (MSME) sector to tap the inherent growth potentiality.

The recent 2 per cent interest rate subvention for MSME sector needs to be passed on by banks with incremental push in credit.

2. Better Lending Ecosystem

In the backdrop of sizeable capital infusion in the last two years and many banks having built reasonable levels of provision coverage ratio, the next move should be to dispense faster credit in the midst of comfortable liquidity when weighted average call rate (WACR) is trading below the policy rate.

RBI assures durable liquidity comfort with its innovative interventions. When lending scope is expanding, the year-on-year (YOY) credit growth of banking industry at 12.2 per cent as on 19 July needs more aggressive push to realise the objectives of the policy.

The present deposit growth at 10.6 per cent is subdued but is set to eventually increase with recent approval of unregulated deposit schemes bill 2019 and diminishing sheen of non-banking financial company (NBFC) sector.

Besides reduction of repo rates to a nine-year historic low of 5.4 per cent, RBI is forming an ecosystem for banks that could significantly step up credit growth. Risk weights on unsecured consumer credit (except for credit card receivables) are brought down from 125 per cent to 100 per cent.

Relaxing the bank exposure norms prescribed for loans to NBFC sector by raising the limit to 20 per cent of Tier-1 capital instead of 15 per cent can provide better leeway.

In addition, the bank loans to registered NBFCs for on-lending to certain preferred sectors will now be classified under priority sector segment. Banks struggling with new wave of bad loans have learnt to manage them in the midst of delayed debt resolution and exacerbated aftershocks in the aftermath of NBFCs fiasco.

Banks are now gradually limping back to normalcy evident from Q1 results of some of the banks. With rising impetus on deepening electronic payment and settlement system in line with RBI’s payment system Vision-2021, banks can collaborate with expanding network of retail payment service providers to increase further outreach and deepen customer relationship and thereby augment deposit growth to create more resources to lend.

3. Early Sign Of Economic Revival

The southwest monsoon gained intensity and hence, the rainfall during the second half of the season has been forecast to be normal that could help revive the agriculture sector.

The capacity utilisation of manufacturing sector marginally increased from 75.9 per cent in Q3 to 76.1 per cent in Q4: 2018-19 indicated by the order books, inventory and capacity utilisation survey of RBI.

Similarly, there is marginal improvement in RBI’s business assessment index for Q1: 2019-20. The services purchasing managers index too increased from 49.6 to 53.8 in July. The input cost pressures from prices of agriculture and industrial raw material continued to ease in May and June 2019.

They collectively indicate early signs of recovery to be further strengthened by revival of investment more importantly from the private sector that is in fence-sitting mode for quite some time.

Resultant regeneration of demand for credit from industry will supplement the efforts of banks. RBI having taken best possible measures has passed on the baton to banks to transmit lower lending rates and accelerate flow of credit to industry and commercial sector to pump prime the economy.

The renewed coordinated efforts of banks should be able to revive the muted consumer confidence index of RBI back to uptrend. Having set the stage, the action lies in its delivery to make policy initiatives work.