The Reserve Bank of India (RBI) trimmed the key repo rate by 25 basis points on Thursday in a bid to bring down the cost of money and boost the faltering economy. But the rise in bond yields —the benchmark jumped 9 basis points to 7.5% — suggests long-term money is going remain expensive primarily due to the large borrowings by the government in the first half of 2019-20.
This is despite the fact that the RBI allowed banks an additional 2% carve-out within the mandatory SLR requirements to help meet the liquidity coverage ratio, a move that should reduce the demand for bonds.
In fact, although the RBI is tipped to cut the repo by another 25 basis points in June or August, as inflation will likely stay benign, these would only help bring down short-term rates with the long bond yields remaining at higher levels given the high fiscal deficit. “Data shows that fiscal risks are for real. The central government has signed up for a higher fiscal deficit for FY20 than promised earlier. State fiscal and borrowing data suggests that India’s states are running a higher deficit than budgeted. And PSE borrowings are also elevated,” Pranjul Bhandari, economist at HSBC India, noted.
In what could be a double whammy, the economy could remain sluggish. As the RBI observed the “output gap remains negative and the domestic economy is facing headwinds, especially on the global front.” Should the monsoon turn out to be less than normal, growth in 2019-20 could be even slower than the central bank’s lowered estimate of 7.2%. “We believe the RBI’s growth projections remain somewhat optimistic, as we expect FY20 GDP growth at 6.8%,” Sonal Verma, economist at Nomura, wrote.
Concerns on slowing growth and the possibility of money staying expensive saw investors rushing to book profits in the stock market the Sensex lost 0.5% to close at 38,684.72.
Indeed, RBI governor Shaktikanta Das said the transmission of policy rate cuts was a work in progress and that “more needs to be done”.
“The 25 basis cut in the repo in February has seen lenders drop their marginal cost of funds based lending rate by up to 10 basis points.We hope to come out with some guidelines, which will ensure effective transmission,” Das said.
State Bank of India managing director-retail and digital banking PK Gupta said the state-run lender has linked some products to the policy rate where transmission should happen. “In case of advances linked to MCLR, a reduction of anywhere between 7-10 basis points can happen,” Gupta said.
Economists caution that unless the pace of increase in bank deposits picks up, lenders will remain constrained in their ability to grow their loan books. SBI’s Gupta said some flexibility is required on liability side to aid transmission and that the lender had built that.
The RBI trimmed its headline CPI inflation forecast for H1FY20 (April-September) to 2.9-3.0% y-o-y from 3.2-3.4% and sees the trend towards a reading of 3.5-3.8% in H2FY20 (down from 3.9% in Q3FY20, with risks broadly balanced. For FY21 (year ending March 2021), it sees inflation in a range between 3.8% and 4.1%. The revision assumes normal monsoon. The monetary policy stance was left unchanged at ‘neutral’.
The committee noted, “there are some signs of domestic investment activity weakening as reflected in a slowdown in production and imports of capital goods. The moderation of growth in the global economy might impact India’s exports”.
It added that on the positive side, higher financial flows to the commercial sector augured well for economic activity while private consumption, which has remained resilient, is also expected to get a fillip from public spending in rural areas and an increase in disposable incomes of households due to tax benefits.
The committee projected retail inflation at 2.4% for the previous quarter from earlier projection of 2.8%, while also substantially lowering the forecast to 2.9-3.0% range for H1FY20 from 3.2-3.4% previously, and expecting a rate of 3.5-3.8% for H2FY20. The committee will also carefully moniter the fiscal situation at the general government levels for the same.
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