With RBI governor Raghuram Rajan's announcement of keeping the policy repo rate unchanged at 7.25 per cent, there have been mixed reactions fromt eh industry. The industrial body FICCI is upset and has sought steps to encourage demand and investments.
In its third Bi-monthly Monetary Policy Statement for 2015, RBI stated the following:
“As per the basis of an assessment of the current and evolving macroeconomic situation, it has been decided to:
• keep the policy repo rate under the liquidity adjustment facility (LAF) unchanged at 7.25 per cent;
• keep the cash reserve ratio (CRR) of scheduled banks unchanged at 4.0 per cent of net demand and time liability (NDTL);
• continue to provide liquidity under overnight repos at 0.25 per cent of bank wise NDTL at the LAF repo rate and liquidity under 14-day term repos as well as longer term repos of up to 0.75 per cent of NDTL of the banking system through auctions; and
• continue with daily variable rate repos and reverse repos to smooth liquidity.
Reacting to that, Dr. Jyotsna Suri, President, FICCI said: “The decision of Central Bank to keep the policy rate unchanged is disappointing for the industry. Given that the industrial growth still remains volatile and demand conditions have not seen much improvement, there is a need to give policy stimuli to encourage demand and investments.”
“With a pick up in the monsoons, inflation is expected to remain range bound and within Reserve Bank of India’s indicative trajectory. Additionally, the latest capital support provided by the Government to the Public Sector Banks should enable effective transmission into lower lending rates. Hence, we do hope that the Central Bank will consider an accommodative policy stance much ahead of the next scheduled bi-monthly monetary policy”, further added Dr. Suri.
The rate of inflation is on the higher side so RBI did not cut the repo rate.As the monetary policy statement pointed out: “Headline consumer price index (CPI) inflation rose for the second successive month in June 2015 to a nine-month high on the back of a broad based increase in upside pressures, belying consensus expectations…Food inflation rose 60 basis points [one basis point is one hundredth of a percentage] over the preceding month, driven by a spike in prices of vegetables, protein items - especially pulses, meat and milk - and spices.”
Food prices are something that the RBI cannot do much about. But prices on the whole have been going up as well. As the monetary policy statement pointed out: “Excluding food and fuel, inflation rose in respect of all subgroups other than housing. The momentum of price increases remained high for education. Inflation pressures increased for personal care and effects and household goods and services sub-groups. Inflation in CPI excluding food, fuel, petrol and diesel has been rising steadily since April.”
RBI monetary statement reveals an interesting data that “Since the first rate cut in January, the median base lending rates of banks has fallen by around 30 basis points, a fraction of the 75 basis points in rate cut so far.”
The bi-monthly policy statements of April and June indicated that the accommodative stance of monetary policy will be maintained going forward, but monetary policy actions will be conditioned by
fuller transmission by banks of the Reserve Bank’s front-loaded rate reductions into their lending rates;
(b) developments in food prices and their management, especially the effects of the monsoon, while looking through both seasonal as well as base effects;
(c) a continuation and even acceleration of policy efforts to unclog the supply side so as to make available key inputs such as power and land, as also re-purposing of public spending from poorly targeted subsidies towards public investment and reducing the pipeline of stalled investment; and
(d) signs of normalisation of the US monetary policy. In the June statement, it was pointed out that a targeted infusion of bank capital is also warranted so that adequate credit flows to the productive sectors as investment picks up.
”During 2015-16 so far, inflation conditions have evolved around the path projected in April and June bi-monthly policy statements, though they surprised somewhat on the upside in June. Large base effects, which the Reserve Bank will look through, are expected to pull down headline inflation in July and August. From September, favorable base effects wane.”
Another crucial point is that Banks on the whole have been using the restructuring route to postpone recognizing bad loans as bad loans. Which means that the bad loans of banks (particularly public sector banks) will keep piling up. And hence, the banks will not cut lending rates in line with future cuts in the repo rate as and when they happen.
And therefore the most thinking part is that the increasing rate of the the stressed advances over last one year.On March 31, 2014, the stressed advances stood at 9.8% of the total advances. A year later this had jumped to 11.1%. The situation in public sector banks is even worse with stressed advances jumping from 11.7% of advances to 13.5%, between March 2014 and March 2015.
As one of the deputy governors of the RBI SS Mundra had pointed out in a recent speech: “There has also been an increase in incidence of suits filed against defaulters and cases of willful default- an unwillingness to pay, despite an ability to pay. These problems could have their genesis in a failure to exercise the right amount of prudence and due diligence on part of the banker or an ab initio intent of the borrower to defraud the bank.”
Another important thing to be noticed that the trust also needed for a banker-borrower relationship to work well has broken down. As Mundra said during the course of his speech: “Recent spurt in instances of forensic audit being conducted by bankers on their borrowers signifies a breakdown in the implicit trust The banker-borrower relationship is essentially symbiotic as both need each other. Both have certain expectations from the other and when these don’t get fulfilled on account of a malafide or fraudulent intent on the part of either of them, the relationship gets strained.”
Relative to the projections of the second bi-monthly statement, inflation projections in this bi-monthly statement are elevated by the higher than expected June observation but reduced by prospects of softer crude prices and a near-normal monsoon thus far. This implies that inflation projections for January-March 2016 are lower by about 0.2 per cent, with risks broadly balanced around the target of 6.0 per cent for January 2016.