Reserve Bank of India Governor Shaktikanta Das appeared to be in a flamboyant mood when he started unveiling the latest monetary policy review — the last for the current financial year and the first for the current calendar year.
It was widely believed that with the retail inflation touching 7.35 per cent rate in December 2019, which is well above the RBI’s comfort zone — RBI is mandated to keep retail inflation at 4 per cent with a leeway or 2 percentage points — there was no question that the RBI could cut interest rates to boost the flagging economic growth in the country. The RBI could also not have increased the interest rate because by all accounts, the spike in inflation, though sharp, was expected to be transient.
So it was not a surprise that Governor Das announced that all six members of the Monetary Policy Committee voted to keep the repo rate — that is the rate at which banks borrow money from the central bank — steady at 5.15 per cent.
Yet, the RBI Governor followed up this announcement by stating: “While this decision may be on expected lines and perhaps widely discounted, it is important not to discount the Reserve Bank of India. It has to be kept in mind that the central bank has several instruments at its command that it can deploy to address the challenges that the Indian economy currently faces in terms of the sluggishness of the growth momentum.”
What are the key decisions by the RBI?
Apart from the monetary policy review in which the RBI stated that even though the monetary policy space exists for a rate cut but the decision would be taken at an opportune time, it also unveiled a long list of the so-called “Development and Regulatory” policies to boost economic growth in the country.
There are four key elements to this new strategy:
1. Undertaking 1-year and 3-year repos:
Repo rate is the rate at which banks borrow from the RBI. But this used to be an overnight rate. That is to say, if the bank borrows some money today, it has to return tomorrow. But now the RBI has stopped the repo from being an overnight rate and will be conducting it over a 14-day period.
More importantly, the RBI will conduct 1-year and 3-year repos up to an amount of Rs 1 lakh crore. This essentially means that a bank can take money from the rate at an interest rate of 5.15 per cent (which is the repo rate) and use it for lending onwards; it has to return this money only after 1-year or 3-year as the case may be.
How does this help?
A big problem with monetary policy in India has been the lack of transmission. In other words, while the RBI has aggressively cut repo rates, the interest rates in the broader economy have not come down — this is called “the lack of monetary transmission”. There were two big reasons for repo rate cuts being ineffective. One, any bank’s cost of funds was much higher. That is to say, in the past, they had borrowed funds at much higher costs and similarly, they had committed to paying a higher rate of return as well to their depositors. A sudden and sharp fall in repo rate did not affect them much because they could not renege on their past commitments. Moreover, (and secondly), the amount of funds that a bank borrowed from the RBI was a minuscule amount in relation to its overall borrowings. So even if a small proportion of its borrowings were now available at a cheaper rate, it did not help matters much.
But now that the RBI is willing to provide Rs 1 lakh crore to the banking system at 5.15 per cent, there is no reason why a bank cannot borrow from the RBI at this rate and lend onwards to the final consumers. Doing this would lead to a substantial reduction in the interest rates charged in the economy. For instance, most home loans are being sold at 8 per cent interest rate; existing customers are actually paying as much as 9 per cent.
2. Relaxation of CRR for lending to key sectors:
The RBI has announced that any incremental lending (retail loans) by banks for automobiles, residential housing and loans to micro, small and medium enterprises (MSMEs) to automobile between January-end and July-end will not attract CRR restrictions.
How does this help?
CRR is the Cash Reserve Ratio and it is the amount of funds that a bank has to park with the RBI as part of prudential norms. The higher the CRR, the lower the amount of funds available with banks to loan to customers. In fact, in times of high inflation, RBI typically raises the CRR because it wants to restrict the amount of money floating in the market. However, under the circumstances where the inflation spike is seen as a transient development, the RBI has chosen to do the reverse — hold off CRR for incremental lending in key sectors in an obvious bid to boost credit growth and perk up consumption.
3. Extension of One-time Restructuring Scheme for loans to MSMEs
According to an existing scheme, those MSMEs who were struggling pay back their loans as of January 1, 2019 were given a one-year extension to “restructure” their loans with the banks by March 31, 2020. This facility has now been extended to MSME loans that had started defaulting as of January 1, 2020; they will now have till December 31, 2020, to restructure their loans.
How does this help?
Restructuring a loan means ironing out a new schedule to pay back the dues. This can be done by tweaking the monthly dues, the overall tenure etc. The RBI noted that “the Micro, Small and Medium Enterprises (MSMEs) sector plays an important role in the growth of the Indian economy, contributing over 28 per cent of the GDP1, more than 40 per cent of exports while creating employment for about 11 crore people”. Considering the importance of MSMEs in the Indian economy, the RBI has decided to be lenient with MSME defaulters and it hopes that, given some time and leeway, these MSMEs will be able to recover and pay back their dues, especially as the economy improves.
4. Leniency towards delays in commercial real estate projects
The RBI has given an additional year before a loan to a real estate project, which has been delayed “for reasons beyond the control of promoters”, faces downgrading (in terms of asset classification). Typically this leniency is afforded to loans towards non-infrastructure projects.
How does this help?
Again, the RBI is choosing to adopt an outlook wherein it understands that many commercial real estate projects are stuck due to genuine reasons and not because the concerned promoter is a crook. By downgrading such loans to a non-performing asset status will, thus, not help anyone — neither the developer, nor the bank, nor the broader economy. Instead, by giving them an extension, the RBI is hoping that developers would be able to focus on getting fresh funds and finish their projects quickly — thus resolving the whole problem.
5. Loans to Medium-sized enterprises to be benchmarked to repo
In the past, the RBI has mandated that retail loans to micro and small enterprises should be benchmarked to the repo. This brings down the rate at which banks can lend to these sectors. This provision has now been extended to medium-sized enterprises.
What is the upshot?
All in all, the RBI has unveiled a pretty dramatic set of changes even though, on the face of it, no repo rate change happened. The RBI has been very imaginative with the use of the CRR and regulatory forbearance to boost lending and economic growth. In particular, what is striking is the dramatic change in the approach that the RBI has towards those in the real estate and MSME sectors who are defaulting. The RBI realises that many of them are failing for no fault of theirs — it is the broader economy that is bringing them down, and that given some additional time and another round of funding, they may yet recover.
It is this kind of imagination that many expected Finance Minister Nirmala Sitharaman to show in the Union Budget as well. Governor Das may have excelled where the FM perhaps failed.
But there is always a flip side to diluting prudential norms. It is a bet that the RBI has taken. If lending restarts and the economy picks up, the forbearance would have paid off. If not, then things will get worse.