The Rate Cut Pause – Defending the RBI Governor!

The monetary policy committee (MPC) in its meeting today decided to take a pause on the rate cut, quite against the market expectation. However, the difficulty faced by the RBI governor during the post-policy press conference to justify a rate pause was evident. After all, growth has fallen to several years’ low of 4.5%, growth projections for FY20 has been cut again from 6.1% to 5%, after being cut from 7% to 6.1% in the last meeting and no sign of pick-up in any of the growth drivers. Yet, the reasoning was very simple. Rates have already been cut by 135 basis points and it takes time for the transmission and rate cut impact to be felt by the economy. After all, you cannot accelerate a recovery by simply increasing the dosage. That it was a unanimous decision makes it more credible. So, what made him so defensive??

The market expectations were primarily based on the fact that second quarter GDP has decline sharply to 4.5% and RBI would do more to fulfil its responsibility. Further, even though, inflation has risen, that too, quite sharply, it is all because of food prices and transient in nature. CPI excluding food & fuel, as per the policy statement, has actually declined further from 4.2% in Sept to 3.4% in Oct.

While the action is logical as stated earlier, its statement that “there is monetary policy space for further action” has, possibly, given voice to the question – why not now?? (Could they have done without inserting this line??). It must be understood that the current phase of growth slowdown is not impeded by monetary policy decisions. This is much like in the rest of the world where despite several rate cuts, huge monetary easing and rates moving into negative territory, economies are not even sputtering, leave alone racing. After all, which company would ever make an investment when the aggregate capacity utilisation has come down from 73.6% to 68.9% in just three months (Seasonally adjusted – down from 74.6% to 69.8%, as stated in the policy statement), whatever may be the level of interest rate.

MPC’s decision must also be looked from the perspective of the current liquidity situation in the market. As per the statement, average daily absorption of liquidity under LAF by RBI was Rs 1.99 lakh crore during October which further increased to Rs 2.4 lakh crore in November. This is a far cry from the situation about a year ago with injection of liquidity to the tune of close to Rs 1 lakh crore in Dec’18 and Rs 32,900 crore in Jan’19, which turned to absorption by Rs 27,900 crore in Feb’19, after RBI made its first rate cut in this cycle. The reversal from injection to absorption implies that there are simply no takers for this money even though it has become cheap. (While transmission is certainly an issue, the rate cut at policy level still has an impact on credit off-take if there is a genuine demand). Imagine this money finding its way into the economy, what would be its impact on inflation? (And it would enter through consumption side only and not investment side, considering the current state).

And, that brings us to why the governor was so defensive. The answer possibly lies in a question posed to him during the conference – What was the reaction of the North block to the sharp downward revision of the growth projection?

So, was it a strong disapproval from the North block to the mild-mannered governor just before he entered the conference that made him so defensive?!

 

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