Why RBI is becoming less accommodative

Rates don’t change, but policy stance shifts from accommodative to neutral. Bank lending rates are unlikely to reduce as important factors such as asset quality, recapitalisation and other schemes, including loan rejig plans, do not get fired up amply yet.

The Reserve Bank of India’s quarterly monetary policy committee (MPC) review has nearly coincided with Union Budget 2017. In the backdrop of no big changes, the equity and bond markets have remained unchanged - more or less flat and quiet as a whole.

After the fiscal stance taken in the Budget by putting the deficit at 3.2 per cent of GDP, every market participant almost concluded a 25 bps rate cut in the present quarterly review, which was fortunately not to be.

The fiscal consolidation path being well set and the low fiscal deficit paved the way for a rate cut.

But RBI governor Urjit Patel has kept the interest rate unchanged for the third time in a row, shifting the policy stance to neutral after one-and-a-half years of accommodative stance.

This signals a possible end to the downward interest rate cycle. But the lending rates, for the reasons explained, fail to relent.

The other reason for the stationary stance is attributable to both domestic and global policy uncertainties and the need to have elbow room to manoeuvre than to rush through a rate cut.

This has prevailed over the RBI governor’s mind in not only averting a rate cut but also pulling down to neutral gear to autopilot mode.

Neutral rate also means that the current level of repo rate would prevail, while accommodative rates may give rise to further cuts in interest rates, which is not going to be the case.

Fixed income investors need to take note that the RBI governor suggests taking small savings scheme returns to the 10-year government security yield. The current yield is much lower than the 7.5-8 per cent yield that some of these securities give to their investors.

Patel disclosed his mind in his press conference that there is scope for lending rates to come down further because of policy rate cuts already coming down up to 175 bps, and lending rates (weighted average) up to 85-90 bps.

He therefore hopes for some more transmission even as CEOs of banks like SBI and ICICI concur.

However, the policy documents on the RBI’s website are reported to say that the environment for timely transmission of policy rates to bank’s lending rates will be considerably improved, only if non-performing assets dissolve quickly, earlier than later, and capitalisation is hastened.

With a meagre Rs 10,000 crore allocation for banks and asset quality also being poor, it is a tough time for lenders to cut lending rates even as Sarfaesi, loan and securitisation fail to fire up.

In the meantime, finance minister Arun Jaitley had said there is early evidence of increased capacity of banks to lend at reduced interest rates. As of now, the cheapest home loan you can hope to get is from the Bank of Baroda of 8.35 per cent, it is said. It is unlikely that your home loan will come down steeply soon, according to lead financial analyst Motilal Oswal.

The impact of surging oil prices and unchanging food prices on core inflation and potential dislocations caused by US Fed rate hikes will all make policy decisions only more risky and tough.

A fall in domestic inflation and the consequent effect on prices are not to be taken as long-term but transitory.

The six-member MPC of RBI sees inflation touching 5 per cent by the end of fiscal 2018, which is above the 4 per cent target but well within the 2 per cent safety band both ways.

It is intriguing to note that non-fuel and non-food CPI has been stubborn at 4.8-4.9 per cent till date. This combined with all the downside risks discussed above will make the job of the MPC a tightrope walk.

The committee therefore feels that it needs this kind of flexibility to move both ways by shifting the stance from accommodative to neutral.

Also read: What Arun Jaitley did not tell you about taxes in his #Budget2017 speech