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Not a single economist among the 34 surveyed by Bloomberg had predicted this outcome. One might think since we are observing a continued dip in the GDP growth till Q2 of FY2020 and the MPC itself has considerably reduced its projection for FY2020 economic growth to 5 per cent in December review from 6.1 per cent in October 2019, a rate cut would have been in order.
Although RBI has done its job in 2019 with a slew of rate cuts, the argument is that this non-consensus pause was because of the widening of inflation forecast in H2 of FY2020 from 4.7 per cent to 5.1 per cent. Food prices have skyrocketed as a result of heavy rainfall, with cost of onions up 45 per cent in September and a further 20 per cent in the following month, according to the central bank’s statement. Meanwhile, the transmission of rate cuts to the credit markets has remained dismal. The graph below indicates the spread between the MCLR and repo rate has expanded significantly in 2019.
Loans are not getting any cheaper, because banks are shying away from transferring the entire repo rate cut to customers. A reduction is repo rates would mean banks will need to pay less for borrowings and are ideally supposed to pass on this benefit to customers. In either scenario, this has weakened the market and showed that growth can wait from a policy orientation point of view.
A few quarters back when deposit growth was lagging credit growth, banks could not afford to cut deposit rates, particularly when small savings offered higher rates. But now, as seen in the graph below, bank deposits have started growing steadily.
We are in the midst of a ‘growth recession’ – India’s gross domestic product (GDP) growth dropped to 4.5 per cent in the July-September quarter of 2019-20, a rapid decline from the government’s ambitious double-digit growth call not so long ago.
If the economy continues on this trajectory, India’s dream of becoming a $5 trillion economic behemoth will take little more time, which the country can’t afford, given the massive social infrastructure needs of a large population.
The systemic liquidity surplus in the banking system has risen considerably in recent months. The average liquidity surplus under the LAF rose from Rs 28,160 crore in Q1 of FY2020 to Rs 1.3 lakh crore in Q2 of FY2020, to Rs 2 lakh crore in October 2019 and further to Rs 2.4 lakh crore in November 2019, despite a seasonal pickup in demand for cash during the festive and marriage season!
Loan growth has slumped, going back to the demonetisation lows. Reflecting the deepening economic crisis arising from both structural and cyclical issues and a massive fall in consumption demand, bank credit growth rate, for the first time this financial year, has slowed to single digit at 8.8 per cent from 14 per cent in the previous year; these levels where last seen in November 2017.
During this time, the private sector needs swift impetus to start borrowing for growth capex and come out of the ‘cautious mindset’ that they have been forced into – and need a nudge in the right direction in the form of cheaper credit to absorb foreseeable risks. It’s high time banks started changing this stance and looked at a complete pass-through. Currently most public sector banks are enjoying this NIM (net interest margin) improvement to manage their bad asset write-off and private sector banks are using this to compensate for slower loan growth.
Overall loan growth has slowed down
If this non-transmission of rate cuts is the ‘cause of the pause’, then RBI could look at a harder stance to ensure transmission of the repo rate along with NIM definition i.e. repo rate of 5.15 or 250 bps below MCLR whichever is higher, that way banks will have to rework their transmission strategy.
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