Economic Highlights

New Delhi, 7 August 2017

Repo Rate Cut

NO SOLUTION, REWARDS PROFLIGACY

By Shivaji Sarkar

The repo rate cut by RBI is unlikely to benefit the economy except possibly keeping the government’s fiscal deficit a bit lower. It will also benefit the government as it would reduce its burden on home loan subsidies marginally.

The sudden repo rate cut by 25 points to 6 per cent at a time when the householders and small depositors are gasping has not been seen to be a benign act. It is to affect retirees, women and others almost at all levels of the society. The banks have been fast on reducing deposit interest rates though prefer not to pass the benefit to lenders.

What is a repo rate? Borrowers take loans from banks and financial organisations, who provide these loans after charging a certain amount of interest. Therefore, the rate at which the borrower takes the loan is known as the cost of credit. Banks borrow money from the RBI by selling their surplus government securities. The rate at which they sell these securities to the RBI is known as the repo rate - repurchase rate.

Presently, the RBI monetary policy does not believe that the cost of credit has increased. A high repo rate results in higher cost of short-term funds. If it is low the banks or businesses will have to pay less interest payment on borrowed funds. In other words, it benefits the businesses more and is supposed to give a boost to their activities. It may benefit a new home loan seeker but does not benefit the one who has already taken one.

The rate was cut because the inflation is stated to be at its lowest in a few years. The consumer price index (CPI) hit a low at in June at 1.5 per cent, though there are indications that since it has shown some rise. Food prices have shown a fall though vegetable and fruit (considered luxury) prices have not. The RBI is targeting 4 per cent CPI inflation but there are views in the government that the Central bank is being conservative in its estimates.

One forgets that even this low inflation is over the high inflation hit economy of 2010 to 2014, when the cumulative inflation touched around 48 per cent. Ignoring this aspect of the economy and suddenly lowering the interest rates may not be in the interest of the banks, business and the common man.

Market observers feel that the prices are unlikely to remain at that low level. The reason for low inflation has been many, less cash in the economy, less production, low demand. The monetary policy committee (MPC) is concerned that that private investment is low. (The corporate are not investing their reserves).

The RBI stated that it is concerned of the infrastructure bottlenecks and slow project clearances. The government and the RBI are worried about large stressed corporate borrowers. They were unable to repay the huge debts they have taken. It has added to the woes of huge NPAs of public sector banks. The large recapitalisation of banks is being done. It is hitting government finances.

In other words, the depositors’ money is being given as loan. These are turning as stressed funds and the depositor is losing on two counts – his interest rates are being lowered and his deposits’ safety at least notionally is affected.

The corporate are not paying back even the principal amount, rescheduling their payments and trying to get concessions. So even without repo rate cut large borrowers are getting benefits for their profligacy. Interest rates should be increased to drive away businesses from seeking frivolous loans and thriving on it.

The banks are being run on the deposits by the common man. They are losing on all fronts. Their interest accruals are coming down. The policy on income tax has affected even meagre accruals. The policy makers need to remember that interest rate on deposits is a hedging against inflation and compensation by the banks for using their money to do business. It does not come under the definition of income.

Giving the depositors less benefit and tax hounding does also not help the economy. It further reduces their capacity to purchase. It is evidenced by the fall in the Nikkei’s manufacturing purchasing managers’ index (PMI) to 50.9 in June from 51.6 in May, signaling stress in the manufacturing sector. The PMI is an indicator for how the buyers are moving to the market.

The manufacturing growth has eased to a four-month-low in June owing to weak client demand, and concerns related to GST. It is a transition and the GST is yet to settle down. It has added to the cost of business. So would it again be inflationary? The business is skeptical but do not rule it out. If it adds to the cost, there are two options – add that to the prices or absorb it. If it is absorbed the profit margins are likely to be dip.

The overall factory output in May slowed down according to ministry of statistics and programme implementation data. The IIP rose 1.7 per cent slower than 3.7 per cent in April. Eight core industries rose 3.6 per cent and non-core industries slowed down further. Even job data was not benign. The use-based classification of industrial output showed that production of primary goods was up 3.4 per cent while capital goods production fell 3.9 per cent. The category of infrastructure and construction goods saw a 0.1 per cent increase in output.

According to the Centre for Monitoring the Indian Economy, 12.3 per cent of all projects -- both public and private -- were stalled in the first quarter of 2017. That's the third-highest level recorded since June 1995 and the first time since 2004 when over a fifth of private-sector projects have been stalled. This isn't a problem that can be solved with a 25 or even a 50-basis point cut in the headline policy rate. 

The repo rate cut does not seem to help any of these except possibly moving the deposits away from the banks. Further, linking all policy framework to rate cut is not prudent. It is double-edged sword. The interest rates are the lowest and bank charges at their highest. That is where correction is needed. Let the nation have a re-look at the interest rates. Lower rates certainly cannot boost the economy but lower bank charges can. ---INFA

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