HYDERABAD: The RBI Thursday reduced key policy rates by 25 bps - 0.25% - but refused to set the rhythm for a rate easing cycle.
Usual suspects like volatile global crude prices, fluctuating currency, global headwinds, tight fiscal situation and uncertain weather could play havoc in the coming days and this apparently has prompted RBI’s neutral policy stance, giving it room to either raise or cut rates in June.
Markets that were in the red chugged in the reverse direction soon after the policy announcement as traders resorted to buying. But bond markets sulked - with yields spiking 10 bps -as if they don't have a dance partner.
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Perhaps traders wanted clarity on management of liquidity, which is flowing out of the banking system at a faster clip and whether RBI will get ahead of the game to contain the deficit situation. When the liquidity puzzle is solved, rate transmission happens faster into the real economy.
The central bank's Monetary Policy Committee (MPC) - the guardians of our nation's price stability -- noted several reasons and setbacks for not entering into an accomodative zone.
Slowing global growth, weak domestic investment activity, underlying food inflation risks, negative output gap, pale export scenario and bank credit growth, which is yet to broad base. These factors, and the headline inflation, which remained gentle at 2.57 per cent in February prompted the MPC to bite the rate cut bullet for the second time in a space of just 60 days. Looked in isolation, 25 bps is just table stakes, but reasonable enough to boost market sentiment.
So interest rates on home or auto loans too should fall right? Wrong.
Citing liquidity shortage and high credit-deposit ratio, banks don't want to be brothers in trade with RBI. For credit growth to take off, banks need to abandon their habit of cheese pairing and instead of the pitiful 5-10 bps cut, they should transmit more. In fact, with regards to effective transmission of rates, RBI did a u-turn, deferring the linking of all retail floating loan rates to an external benchmark indefinitely. An about-face is rarely good, but in this case, banks can grin widely as they have been pushing back citing the need for better alignment of cost of deposits and loans.
So will Thursday's rate cut goose the economy?
Experts reckon that we are staring at a demand slowdown, particularly because non-banking credit is yet to find a proof of life. This lack of credit supply is having a rub on consumer durables and auto companies, and in turn leading demand slowdown. To an extent, Thursday's policy cut will spur demand in auto and consumer durables, but until corporate investments come back, revival won't be at full-throttle. Large businesses are still grappling with high leverage and the ongoing insolvency process is taking undue time.
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On his part, RBI Governor Shaktikanta Das assured that a bobbed and weaved circular on resolution of stressed assets, which the Supreme Court struck down Tuesday, will be in place soon.
Meanwhile, will RBI continue with its traditional open-market operations or indulge in its newfound love of dollar-rupee swaps, or let the market find its momentum on its own? The central bank didn't give any answers.
Which way the RBI moves depedens highly on capital flows. Should they be negligible, with the entire burden of liquidity creation falling squarely on the domestic market operations of RBI, they could use both OMOs and forex swaps. On the other hand, if flows are strong, then the argument to use both OMOs (Open Market Operations) and rupee-dollar swaps becomes weaker.
Currently, we have relatively high real rates of interest. Given headline inflation is trending down and in the absence of corporate investments - which will likely pick up after 2-3 quarters - government expenditure has to drive growth.