May 31, 2023

Monetary Policy, Cost Of Funds And Growth

By Sunil Garodia
First publised on 2020-02-13 12:38:10

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Editor-in-Chief of indiacommentary.com. Current Affairs analyst and political commentator.

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In its February bi-monthly meeting, the Monetary Policy Committee (MPC) of the RBI decided to hold rates while maintaining an "accommodative stance". This was expected as inflation had climbed way above the 4% considered 'normal' by the MPC. Despite regular rate cuts for the last few quarters, growth has refused to pick up. Neither has relatively cheaper credit led to an increased demand for funds. Although the banks have not fully passed on the rate cuts to consumers, the demand for funds is not only dependant on cheap or cheaper funds. There is stagnancy in demand for goods and services in the economy and unless that picks up, entrepreneurs will not plan to invest in new projects or increase the capacity of existing ones. The RBI's decision not to further reduce the repo rate in this meeting was vindicated in a couple of days when it was reported that retail inflation had shot up further to stand at 7.59% in January, the highest since May 2014.

But since spurring growth is a prime concern now, the RBI has unleashed other weapons in its armoury to relieve the banks by making the cost of finance cheaper for them on the one hand and provide them with liquidity so that they can lend more, on the other. Banks have been exempted from providing for cash reserve ratio (CRR) on fresh retail loans disbursed after January 31 to purchase vehicles and homes, and to MSMEs. While this will make the cost of funds cheaper for banks and will channel funds in segments that can spur demand, unbridled and seemingly lucrative (for banks) retail loans can well assume the dimensions of a bubble. Banks have to guard against this.

Then, the RBI has introduced one- and- three-year term repos for a total amount of Rs 1 lakh crore through which the banks can borrow funds from the RBI at the existing repo rate of 5.15%. This will also reduce the cost of finance for banks as they now borrow at a rate between 6-6.5%. While this will make banks secure, it remains to be seen how much of the rate differential they pass on to the consumer. The RBI move had an immediate effect in lowering interest rates in the bond market which went down by 10 to 15 basis points in a matter of minutes after the announcement.

But the problem being faced by the economy is not going to be addressed only by making credit cheaper or infusing liquidity in the system. By all accounts, banks are already flush with funds. Lending is not taking off because there is either no demand or the banks are not interested to lend to the few who do need money. This is either because the projects do not inspire confidence or the bankers have still not got over the fear factor despite changes in the rules and prodding by the finance minister. Retail loans are also not growing at the expected rate because businessmen-borrowers do not want to extend themselves in the face of falling profits in their own businesses and the salaried class is worried about job cuts, delayed or no raises and smaller bonuses. Despite all the right boxes being ticked by both the government and the RBI, things will change only when the sentiment improves. The scary part is that no one knows how and when will that happen.