Depending solely on monetary policy easing may not be a sufficient remedy if the Indian economy has to scale to the long-awaited double-digit GDP growth.
In January 2014, the repo rate was at 8 percent. Since then, the Reserve Bank of India (RBI) has consistently reduced it to bring it down to 5.75 percent in June. With this latest rate cut, the repo rate has reached a nine-year low (last time these levels were seen in 2010). Even after the RBI brought the repo rate lower by 2.25 percent, the Indian GDP growth is at a five-year low. This triggers the question whether we are banking too much on the RBI repo rate cuts for stimulating the economy (when there is no established mechanism for transmission of rate cuts by banks to end-users).
Of the mentioned 2.25 percent rate cut by the RBI, the banking system has passed on only meagre 60 bps of rate cuts to end-users. If the disparity (in terms of transmission) is so large, can the RBI monetary policy alone revive the economy? It should be noted that consumption and investment revival will happen not when RBI cuts the rates but when banks cut the rates. If we really wish to translate the benefit of the RBI’s latest stance of “accommodative” monetary policy into economic growth, the RBI may have to “mandate” the transmission framework of linking the repo rate and banks’ lending rates.
In this backdrop, the new finance minister’s first budget on July 5 will be key in changing the narrative from defaults to durable growth. Fiscal prudence, undoubtedly and inarguably, is the foundation for sustenance of any economic growth. However, when the economy seems to have hit an evidently deeper rough patch, providing fiscal respite may be merited by the finance minister (especially when the monetary policy has not been able to stimulate the economy either due to non-transmission or otherwise). India has done a tremendous job of fiscal discipline by reducing fiscal deficit figures from 6.5 percent in 2010 to 3.4 percent in 2019. This provides an important cushion to use both legs of monetary and fiscal tools to achieve economic revival.
Relaxation in Leverage Ratio
Besides the repo rate cut, the RBI has been constructively dovish in the recent monetary policy by measures including a relaxing leverage ratio for banks in a bid to help them expand their lending activities. The leverage ratio stands reduced to 4 percent for Domestically Systemically Important Banks (DSIBs) and 3.5 percent for other banks (Basel – III framework prescribes minimum leverage ratio of 3 percent). The leverage ratio is Tier-1 Capital as a percent of the bank’s total exposures. A lowering of the ratio would imply an expansion of the bank’s lending activity (at a given numerator Tier-1 capital) as it allows banks to lend more from the same amount of Tier-1 capital they hold.
Further, the leverage ratio is one of the four indicators to place a bank under the RBI’s prompt corrective action (PCA) framework. The relaxation in leverage ratio could help some of the banks currently under PCA framework though that alone may not be sufficient to bring a bank out of PCA as there are other requirements such as an improvement in net NPAs and the capital adequacy ratio to be met.
As the repo rate is at a nine-year low, even with an “accommodative” stance, the leg room with the RBI for further rate cuts may be limited. Depending solely on the monetary policy easing may not be a sufficient remedy if the Indian economy has to scale to the long-awaited double-digit GDP growth. A single prescription may not be adequate to clear all snags of the economy.
(The author is Senior Vice President and Head of Research (Wealth), Centrum Broking Ltd.)