The appointment of Urjit Patel, as Governor of the Reserve Bank of India (RBI), effective from September 4, has naturally raised expectation among those who were critical of outgoing Governor Raghuram Rajan for not easing enough the monetary policy by cutting rates.
It is relevant in this context to examine the backdrop to Rajan holding the RBI’s repo, or short-term lending rate, at 6.5 per cent in his last monetary policy review earlier this month.
Since January 2015, Rajan has cut lending rates by 150 basis points (bps) but banks have only cut their interest rates by about half of that. To nudge banks to transfer the benefit of rate cuts, Rajan even announced a shift to the marginal cost of lending (MCLR) regime.
Under the MCLR, banks need to consider their marginal cost of funds, or the cost incurred on incremental deposits across different maturities, to decide on interest rates.
However, three months after the MCLR was launched on April 1 this year, banks have hardly cut their lending rates.
ICICI Bank and Axis Bank recently cut rates by only 5 bps. So far, Axis Bank has cut its rates cumulatively the most — by 30 bps. State Bank of India, ICICI Bank, HDFC Bank, Bank of Baroda, IDBI Bank, Punjab National Bank and Syndicate Bank have cut their rates only in the range of 5bps — 20bps.
From the state-run banks’ point of view, their accumulation of massive non-performing assets (NPAs), or bad loans, that is impacting profitability, is keeping them from cutting rates.
When talking about this challenge for Urjit Patel as the RBI Governor, it should also be kept in mind that his moorings are as monetarist as the outgoing Governor, and he is considered to attach the same importance to inflation control as Raghuram Rajan.
Patel is also known to be opposed to boosting government capital spending at the risk of a higher fiscal deficit.
His views on monetary policy were expressed at the time Rajan held rates in the February 2015 review after making an unexpected rate cut the previous month — the first in nearly two years.
Patel at the time elaborated on the “important backdrop” to Rajan’s move to hold rates.
“We are in the midst of the age of competitive depreciation and of a beggar-my-neighbour philosophy. It brings to mind an old African saying that when elephants fight, the grass suffers,” Patel said at the press conference to announce the policy review, on the trend of accommodative monetary policies being adopted by developed economies.
“While the ECB (European Central Bank) and the Bank of Japan are printing money and devaluing their currencies on one hand, the US economy is reviving on the other. Anyone in the middle is getting crushed,” he added.