The Reserve Bank of India has done what was expected, addressing liquidity and cost of funds issues at two levels, in is announcements on Saturday. If there is criticism of the move, it will be that the interest rates cuts don’t go far enough, and that more should have been done—a point that critics have made on earlier occasions as well.
The cut in the reverse repo rate was of course imperative, since it had become clear over the past few weeks that banks found the 6 per cent return provided by this channel rather attractive in the current circumstances. This highlighted the “pushing on a string” uncertainty that a monetary stimulus always has to deal with. The lower the returns on safe investments like the reverse repo, the more incentive banks have to lend to companies and consumers. The repo rate has also been cut by the same magnitude of 100 basis points, exploiting the room that the rapid decline in inflation is providing the central bank. All of these measures exert downward pressure on interest rates. It is, therefore, somewhat disappointing from the perspective of policy-makers to hear bank chairmen saying that it is still too early to reduce their lending rates. The longer this adjustment takes, the less effective the stimulus will be and it is important that the RBI understand the operative issues. If needed, it should re-look at interest rates and consider further cuts.
The RBI has also addressed the needs of specific sectors, providing lifelines in a bid to see otherwise viable businesses through a tough few months. Small and medium enterprises have been hit, particularly those operating on the export front. A safety net has been provided through a line of credit to the Small Industries Development Bank of India (SIDBI). The most important of the sectoral initiatives, though, focuses on the real estate sector. Dwindling construction activity can be devastating to the economy, in terms of job losses as well as demand for several industrial products. The RBI’s measures announced on Saturday accord priority sector status to a category of housing loans and allow restructuring of loans made to developers, which will save them from being treated as non-performing. The former should induce flows of funds to home buyers, of which there has been a significant lack in the past few months, while the latter should allow developers to keep construction activity going even when sales remain sluggish. Of course, these measures should be accompanied by strict monitoring of both banks and developers to ensure that the intended responses are actually materializing. Overall, the measures at both levels are appropriate and substantial. At the aggregate level, there is clearly more room available to reduce both the reverse repo and repo rates further, a decision the RBI can make over the next few weeks as new data comes in.
On Sunday evening, the government complemented the RBI announcements with its own stimulus package of measures that will work at different levels. While detailed analysis will follow, it can be said straightaway that the seriousness with which the government has moved from Friday to address a dramatic economic slowdown is to be commended.
