The Reserve Bank of India announced its third quarter review of the monetary policy today, disappointing the rate-cut hopefuls by leaving all key benchmarks unchanged. In the past few months, the central bank has provided enough leeway, by reducing interest rates and adding to cash in the banking system, for banks to start lending again.
But it believes that its changes have not percolated adequately; for example, interest rates charged to borrowers have not fallen by as much. So doing more now may only lead to perceptions of easing with no real benefits. It would much rather save its arsenal for later. The only major gainers of falling interest rates seem to be banks, especially public sector banks who are sitting on a stockpile of government securities. The value of these securities goes up, as interest rates fall, allowing them to book notional gains in their profit and loss account. That has been noticeable in the December 2008 quarter.
The RBI’s outlook for the domestic economy is discouraging, reflecting poor business sentiment for the December 2008 quarter. Service sector activity (except for freight and telecom) is moderating but the agriculture sector is expected to deliver while industrial activity could pick up due to falling commodity prices. Inflation has fallen but the RBI has noted that inflation of primary articles is still high at 11.6% and consumer price inflation continues to hover between 10-11%. Clearly, product prices are not coming down in tandem with commodity prices, as producers try to improve their profit margins.
The RBI would like to see producers do their bit to lower inflation, improve purchasing power and demand, before it eases monetary policy further. So far, the beneficiaries of the rate cuts, SLR/CRR cuts and falling inflation have been banks and industries. The RBI’s logic of monetary easing is mainly to provide a boost to economic growth. If both banks and industries do not do their bit to boost demand, the RBI’s actions are having a peripheral effect. Will banks and industries take the hint, or will they wait for falling demand to bring them down on their knees, before they react?