No more rate cuts?

Was that the hidden message in the RBI credit policy?

Why were markets sorely disappointed with the RBI credit policy? To be fair, the markets were expecting a 25 basis points cut in the interest rates and that is exactly what Dr. Rajan delivered. The real story was possibly hidden behind the reams of data and text that comprised the credit policy. The message was that India Inc should forget about further rate cuts.

The inflation story

One of the primary reasons advanced by Rajan for restricting himself to 25 basis points was sticky inflation. The Met Department has already predicted a deficient monsoon. That is a classic recipe for rising food inflation; one of the most virulent components of overall inflation. The RBI seems to be really worried that inflation could rear its head again if food prices go out of control from current levels.

The other worry is about the uncomfortable weakness in oil prices. The price of oil has reached a stage wherein each dip is leading to bankruptcies among oil explorers. That is typically a signal of a lull before the storm. The RBI believes that any rise in oil prices above the psychological mark of $70/barrel could trigger inflation in India. RBI has maintained that rate cuts will have to be predicated on low inflation. If inflation stays high, further rate cuts may be ruled out. We may be seeing a lull in the rate cut cycle.
Banks; get your house in order!

The policy has a clear message to banks at the centre of the financial intermediation riddle. “Shape up or ship out”. Since the beginning of the calendar year, the RBI has already cut repo rates by 75 basis points. The central bank would be keen to understand two things. Firstly, how smoothly and effectively does this rate cut get transmitted to the final borrower? Secondly, how will it impact credit off-take and cost of credit?

RBI has consistently maintained that the reason for slow credit off-take is not high rates but weak balance sheets. Companies overloaded with leverage and having weak coverage ratios are almost ineligible for credit. Then what is the point of cutting rates?

It’s about supply not demand!

The RBI has been at pains to explain that the core problem in India has been related to supply, not demand. Rate cuts can work when demand needs to be propped up with cheap credit. If low rates were the answer, then US, Europe and Japan would be booming due to cheap credit. But that is not the case. This may serve to underscore the RBI’s belief that, “For an economy that was supply constrained, demand push was never the answer”. Get your supply side in order, first! That means, you can forget about rate cuts for some time! ©

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