Vijay Kumar Gaba: Repo rates

Tuesday, February 21, 2023

Summers could be hotter this year

The Reserve Bank of India has increased the policy repo rate six times in the current financial year (FY23). It has continued to withdraw excess liquidity from the financial system through various means and has mostly maintained a hawkish demeanor, insofar as the policy outlook is concerned.

In spite of (i) aggressive rate hikes; (ii) withdrawal of excess liquidity from the system; (iii) sharp correction in global commodity prices (especially energy); (iv) restoration of supply chains that had got damaged during pandemic resulting in severe supply shortage of key raw materials and inputs; (vi) three consecutive normal monsoon seasons yielding bumper crops; and (vi) slow growth – CPI inflation has persisted above the RBI tolerance range of 4 to 6% and credit growth has accelerated and remained strong. Obviously there is a disconnect somewhere. Even one third of the members of the Monetary Policy Committee of the RBI do not agree with the policy stance of the RBI and have voted against rate hikes.

Personal loans and working capital demand driving credit growth

In a recent report rating agency CARE Ratings highlighted that “Credit growth has generally been trending upward throughout FY23 and remained robust in recent months even amid the significant rise in interest rates.” The report pointed that “Retail and NBFCs have been the key growth drivers for FY23. Besides, demand for capex too is expected to drive industry credit growth.” As per the agency, “Incremental credit growth has risen by 12.2% so far in FY23. In absolute terms, credit expanded by Rs.14.5 lakh crore from March 2022. The growth has been driven by continued and sustained retail credit demand, strong growth in NBFCs and inflation-induced working capital requirement”.

Personal loans, driven by housing and vehicle loans, continue to be one of the fastest growing segments of credit growth. Even in December 2022, “Personal loans grew by 20.2 per cent (y-o-y) in December 2022 from 14.9 per cent a year ago, largely driven by housing and vehicle loans.”

Banking system liquidity turns negative from a large surplus

The banking system liquidity has been quickly evaporating in FY23. From a large surplus a year ago, the banking system liquidity has turned negative in recent weeks. As of January 27, 2023, the banking system liquidity deficit stood at Rs.18,916 crore as against a surplus of Rs.6.4 lakh crore at the beginning of FY23.

Credit growth outpacing deposits

For the fortnight ended January 27, 2023, deposits with scheduled commercial banks (SCBs) stood at Rs177.2trn. The current deposit base is higher by Rs12.5trn as compared to the beginning of FY23. Bank deposits growth continues to lag the credit growth resulting in gradual rise in credit to deposit ratio.

Conclusion

From a plain reading of the above mentioned data points and corroborating evidence, I am drawing the following conclusions:

· The economic growth continues to be highly skewed (K shaped)

The top decile of the population seems to have emerged economically stronger from the pandemic. Record high spend on foreign travel; record sales of high end cars; 9yr high sales of premium homes; are just a few indicators of this trend.

On the other hand, the middle classes have struggled to sustain their pre-pandemic lifestyle. Their savings are depleting; credit card outstanding and rolling credit is rising; and high inflation is hitting their consumption.

The reliance of poor people for essentials like food, shelter, healthcare, education on government is intensifying. Over 800million people are now availing free food.

· Rates could rise further

Persistent inflation, neutral to negative liquidity, high current account deficit (INR under pressure), slowing household savings rate, and credit demand outpacing the deposits imply that the overall environment for rates remains bullish. We may see deposit and lending rates rising further; while the policy rates stay elevated. A pause by RBI may not result in lowering of rates in the short term.

· Growth to remain suboptimal, private capex may remain in slow lane

There is evidence that high real rates may have started to constrict economic growth in India. The real GDP growth in FY24 is forecasted to be 5.8% to 6% by most economists and analysts, though RBI has projected an optimistic 6.4% in its latest monetary policy statement. Private capex may thus remain in the slow lane despite optimistic projections.

· Banks’ margins may take a hit

In the past one year Indian banks have enjoyed strong margins as loans were repriced in tandem with the policy rates. The deposit rates usually get repriced with a lag. We shall see deposit rates rising in the next few quarters impacting the margins of the banks.

· Economic inequalities may rise further

With inflation, high rates, slower economic growth (poor employment generation) continuing to hit the middle classes and poor hard, we shall see the economic inequality continuing to rise further. The consumption of the premium segment may sustain and grow faster as compared to staples and essentials.

Saturday, December 11, 2021

RBI stays committed to growth

In its latest policy statement, RBI has reiterated its unwavering commitment to growth, ignoring the concerns about it missing the inflation curve. There are not many precedence in past two decades when the RBI has shown such unwavering commitment to growth despite mounting inflation concerns and global tightening pressures.

The decision of the Monetary Policy Committee of RBI to maintain status quo on policy rates and keep the policy stance “accommodative” despite mounting inflationary pressures has provided some relief to the financial markets. However, it has divided the experts on the mid-term economic impacts.

The bankers have generally welcomed the RBI’s policy stance as credit and growth supportive. However, economists believe that this leniency on inflation may not end well. They believe that this profligacy of RBI will leave it much behind the curve and force it to make disruptive tightening in mid-term.

There are some questions over the autonomy of MPC also. A small section of analysts believes that the government may have hijacked the MPC agenda, forcing it to ignore its primary mandate of price stability; and support the government through continuing monetary stimulus.

In my view, the monetary Policy Committee (MPC) and RBI have taken the most appropriate path by staying focus on growth.

There is no conclusive empirical evidence available to indicate that RBI has been able to influence prices through monetary policy. On the other hand, the monetary stimulus (lower rates and accommodative liquidity) has invariably shown positive results. This is particularly true in episodes of inflation with negative output gap, implying underutilization of capacities.

There are ample indications to suggest that RBI is working in close coordination with the government. Sharp cut in duties on transportation fuel 2 weeks ahead of MPC meet shows that the government is addressing the RBI concerns on prices.

RBI’s lower inflation forecast for next quarter, when the US Federal Reserve Chairman has indicated that the inflation may not be transitory as believed earlier and OPEC’s resolve to maintain prices around present levels, further indicates that RBI is comfortable with the government’s assurance to reign energy prices.

The latest Monetary Policy Statement of MPC also does not seem to concur with the US Fed assessment on inflation. It continues to believe that inflation is transitory and it will ease in next few months.

To summarize, RBI has made it clear that the monetary policy shall remain consistently growth supportive for next many quarters. It will wait for conclusive evidence on stabilization of growth trajectory before changing its policy stance. Any changes till then will be implemented by managing the liquidity through open market operations.

The governor highlighted in his press statement that “the Reserve Bank has maintained ample surplus liquidity in the banking system to nurture the nascent growth impulses and support a durable economic recovery. This has facilitated swifter and more complete monetary policy transmission and the orderly conduct of the market borrowing programme of the Government. The Reserve Bank will continue to manage liquidity in a manner that is conducive to entrenching the recovery and fostering macroeconomic and financial stability.”