Vijay Kumar Gaba

It’s almost a year since the Reserve Bank of India shifted the course of its monetary policy stance and embarked on the path of monetary tightening and withdrawal of accommodation to reign in runaway inflation. In the course of its journey in the past one year, RBI reversed the entire 250bps of rate cuts made during 2019-2020. 

Besides hiking the policy repo rate, RBI also enforced correction in banking system liquidity to check the demand side pressures on inflation. The banking system liquidity that was running in excess of rupees eight trillion a year ago, has been completely neutralized.

Impact of monetary tightening

It is very difficult to assess the direct impact of the RBI’s monetary policy action and its consequences. Nonetheless, it is pertinent to note how various sub segments of the economy have moved in the past one year. This movement could have been caused by a variety of factors, RBI tightening being one of them.

Inflation

The Consumer Price Index Inflation (CPI) has eased from 7.04% (yoy) in May 2022 to 5.66% (yoy) in March 2023. After mostly staying above the RBI tolerance band of 4% to 6% for more than 15%, the latest inflation reading is within the band, though still closer to the upper bound. If we adjust it for high base effect, material easing in global commodity prices, and significant improvement in supply chains, in the past one year, the direct impact of RBI policy on demand side pressure may not be material. Besides, given the chances of a below par monsoon due to development of El Nino in the Pacific Ocean, the food inflation may spike again challenging the sustainability of the recent fall in CPI inflation.

Money supply and credit

In the past one-year broader money supply (M3) in India has grown at a higher pace than the trend seen in the past one decade; and currently stands at INR227.8trillion.

The commercial banks have not passed on the entire 250bps hike in the policy repo rate to the borrowers. On average lending rates have risen 130 to 150bps. It is pertinent to note that movement in lending rates in India is mostly not in tandem with the policy repo rates. Lenders were also slow in cutting the rates while RBI was in easing mode. Regardless, now since the RBI has already signaled a pause, the probability of material rise in lending rates from the current level is low; implying that the policy rates are more of a signaling tool rather than a driving force for the commercial rates. The commercial rates are more of a function of demand and supply.

In FY23, the overall bank credit grew from Rs118.9trillion to Rs136.8trn, registering a growth of 15%, highest since 2014. Though some moderation in credit growth has been seen in the past one quarter.

The fastest growing segments of the bank credit in the past one year have been personal loans (especially unsecured loans) and financing to NBFCs, (much of this could also be consumer financing related). This clearly suggests that higher rates may not have deterred the demand much.

Growth

There is little evidence to show that the tighter monetary policy of the RBI in the past one year may have directly impacted the economic growth materially. Nonetheless, the growth momentum has definitely slowed down and is not seen picking up from the present low levels in any significant manner over the next 12months. Though the RBI has forecasted FY24 real GDP to grow at 6.4%; most private forecasters estimate the growth to remain slightly below 6%. Declining global growth and poor weather conditions could be the two major factors in the lower trajectory of growth.

Yield curve

The benchmark 10yr bond yields in India are now at the same level as these were a year ago. The short to mid-term yields (30days to 5yr) have risen sharply in the past one year. In the past six month in particular, the overall yield curve has moved down noticeably, except in the 30days to 1yr timeframe where the yields are still higher. Apparently, the poor liquidity in the banking system has resulted in higher near term rates, without impacting the demand materially – more of a lose-lose situation.

To conclude, I would believe that the aggressive tightening by RBI in the past one year, was more of a reaction to the global trend, ostensibly to preempt the outflows and pressure on INR, rather than to stabilize prices and calibrate demand. Given that USDINR has weakened by over 7% in the past one year; and foreign investors have been net sellers in the past twelve months, it could be concluded that RBI would have been better pursuing an independent monetary policy commensurate with the assessment of local conditions and requirements.

I understand the “not for this, things could have been much worse” argument fully and will reply to that some other time.

In an unscheduled press conference yesterday, the RBI governor admitted that the Covid19 pandemic has recently intensified in India. This intensification could derail the still fragile economic recovery. He implied that the impact on livelihoods due to restrictive access to workplace, education and income mediums could be significant and needs immediate attention.

The governor also highlighted that “The global economy is exhibiting incipient signs of recovery as countries renew their tryst with growth, supported by monetary and fiscal stimulus. Still, activity remains uneven across countries and sectors. The outlook is highly uncertain and clouded with downside risks.” He underscored that “Consumer price index (CPI) inflation remains benign for major AEs; in a few EMEs, however, it persists above targets on account of firming global food and commodity prices.”

The governor also highlighted the emerging inflationary pressures and softening bias in bond yields as follows:

·         “CPI inflation edged up to 5.5 per cent in March 2021 from 5.0 per cent a month ago on the back of a pick-up in food as well as fuel inflation while core inflation remained elevated.”

·         “Domestic financial conditions remain easy on abundant and surplus system liquidity. The average daily net liquidity absorption under the liquidity adjustment facility (LAF) was at ₹5.8 lakh crore in April 2021. The first auction under G-SAP 1.0 conducted on April 15, 2021 for a notified amount of ₹25,000 crore elicited an enthusiastic response as reflected in the bid-cover ratio of 4.1. G-SAP has engendered a softening bias in Gsec yields which has continued since then.”

In fact the governor announced that “Given this positive response from the market, it has been decided that the second purchase of government securities for an aggregate amount of ₹35,000 crore under G-SAP 1.0 will be conducted on May 20, 2021.”

It is therefore clear that regardless of the inflationary pressures, the liquidity conditions may remain benign for 2021 and no thought of monetary tightening may be entertained by MPC/RBI. Persistently, poor credit growth also supports this view.

It is pertinent to note that Banks’ non-food credit growth was just 4.9% in March 2021, almost a 4yr low. Credit growth in service and manufacturing sectors continues to remain materially below par; though agriculture and personal credit is buoyant. During March 2021, industry credit off grew a dismal 0.4% yoy, while credit to large industries segment continued to contract (-0.8% YoY). The credit growth pickup in February 2021 failed to sustain. The April credit growth number may still be disappointing, given the widespread mobility restrictions across large states.

Though RBI governor emphasized strongly on the need to support small, medium and unorganized businesses; the credit growth to this segment remains anaemic, highlighting the extreme risk averseness of lenders. Loans for Housing & education; and to weaker sections have also suffered recently. Given that MCLR rates are now stable as most of the transmission of policy easing has already occurred, any material fall in rates may not be expected in 2021.

The recent data on sectoral credit distribution and growth released by RBI discloses some noteworthy trends. These trends are interesting and worrisome at the same time. In particular, the investors may take cognizance of the following trends.

1.    Overall bank credit growth for the month of August 2020 was 6% (yoy). This is the slowest growth in bank credit recorded since October 2017. It is pertinent to note because this slowest rate of growth has happened despite a slew of special credit schemes, lending concessions, and rate cuts announced by the government and RBI since May 2020.

2.    In past 10 years, the services sector has been the top performer for the Indian economy. The share of service sector in GDP is over 55%. Unfortunately, this sector has been hit the hardest by the COVID-19 induced lockdown. The credit growth to this sector has seen the sharpest drop in August. The credit growth to the sector slowed to 8.6% (yoy). NBFCs and commercial Real Estate segments witnessed sharp fall, while the trade credit accelerated by 12.5%, the highest pace since March 2019. This trend shall reflect in the GDP growth for 2QFY21 as well.

3.    In past 3 years, personal loan segment has been one of the key drivers of overall bank credit growth. In post lockdown period this segment has seen consistent decline in credit growth. In August 2020, the growth in this segment declined to 10.6% yoy. The credit card segment has seen the sharpest slowdown in growth during lock down. Whereas the vehicle loan segment saw some acceleration in August 2020 as compared to July 2020.

This trend prima facie sounds counterintuitive. In the period of lockdown and work from home, the use of credit card should have been higher. The record level of online shopping transactions reported by various ecommerce players also does not agree with this trend. The sharp slowdown in this segment could be indicative of (i) banks reducing limits of credit card users as the employment conditions worsened and household stress increased; or (ii) households sharply curtailing their discretionary spending.

The rise in vehicle loan in August with unlock gathering pace, may be indicative of rising preference for personal vehicles over public transport due to COVID-19 infection fears. Unavailability of public transport could also be a key factor. This trend would need to be watched carefully till the public transport become fully operational.

4.    As per HDFC Securities, “Industrial credit growth slowed to 0.5% YoY, from 0.8% YoY in July, led by a reduction in large industrial credit growth. Large industrial credit grew 0.6% YoY, vs. 1.4% in July, but de-grew sharply on a MoM basis (-2% in August, and -2.6% in July). After persistent de-growth, credit for medium industries grew 2.8% YoY. This segment saw strong MoM growth in July and August at 6.6% and 5.3% respectively- indicative of disbursals under the MSME credit guarantee scheme. Within industrial credit, sectors such as textiles, gems and jewellery, glass and glassware and all engineering including electronics saw persistent YoY de-growth. Credit for vehicle, vehicle parts and transport equipment and construction saw accelerating growth. Infra credit growth was flattish, with slowing trends in telecom credit growth.

On a MoM basis, industrial credit de-grew 1.5%, after de-growing 1.9% in July. Naturally, this was led by trends in large industrial credit, which constitutes 83.4% of total industrial credit. Credit to micro and small industries witnessed persistent de-growth at 1.2% YoY. Interestingly, credit to medium industries grew 2.8% YoY, after dipping 3.1% YoY in July. Further, on a MoM basis, credit to medium industries grew 5.3% MoM after growing 6.6% MoM in July. This appears to reflect disbursals under the MSME credit guarantee scheme.”

This trends may belie any claim of broader growth revival in near term.