Don’t Hold Your Breath For Urjit Patel’s Monetary Policy; DeMo Has Made It A Non-Event

The sixth and final bimonthly monetary policy for 2016-17, due tomorrow (8 February), will probably be a non-event, unless Reserve Bank of India (RBI) Governor Urjit Patel decides to turn loquacious on demonetisation (DeMo). If he hands out details on where we are on the remonetisation curve, and also gives a final figure on how much of the scrapped notes returned to banks, he will be the toast of the town.

But as for the monetary part of the policy – rate cuts, et al – there is nothing the Monetary Policy Committee (MPC) can do that has not already been factored in or acted on in advance. A rate cut, if announced, will aid sentiment, but it won’t fundamentally change anything for borrowers.

Post-DeMo, with banks awash with cash, deposit rates and lending rates have crashed. This makes a repo rate cut, or its denial, of mere academic interest. Banks have rushed in where the MPC dallied. As Chanda Kochhar, managing director and chief executive of ICICI Bank, told CNBC TV-18 in an interview, “banks have actually preceded... the monetary policy cuts.” She pointed out that while the RBI cut rates by 0.5 per cent (50 basis points) in 2016-17, banks have cut lending rates by 1 per cent (100 basis points). They could well do more if deposit rates can be cut further, and withdrawals are lower than expected.

Bank of Baroda CEO PS Jayakumar also told the channel the same thing, that a “further reduction on interest rates seem less likely.”

The larger point worth making is that we give too much importance to monetary policy when it is the fiscal side that carries the bigger bazooka.

Consider all the ways in which fiscal/finance ministry policies have impacted us more than monetary policy.

First, DeMo. A government decision to scrap old notes sent growth and short-term demand down, dramatically reducing banks’ cost of funds and raised treasury profits. Nothing the RBI ever did could have achieved this result, even if this wasn’t the intended purpose of DeMo.

Second, inflation has been under control for three reasons other than a robust monetary policy: the moderation in minimum support prices under the National Democratic Alliance (NDA) government; the decision to stick to a downward trajectory in fiscal deficits; and the sharp fall in global oil prices which moderated fuel prices. Commodities reporting sharp spikes in prices, which impacted retail prices, have seen good supply management (eg, tur dal). Monetary policy largely impacts demand; the government’s fiscal policies can impact both demand and supply directly.

But here’s another point: the fiscal deficit was contained by not allowing sharply falling global oil prices to fully feed through to the retail level; if the government had allowed that, the fiscal problem could have been worse, and the resultant fall in prices sharper. This could have revived growth faster, but also fanned retail inflation. By focusing on the fisc, and allowing inflation to fall slower than warranted, the NDA government has proven that it is the fiscal side that is better able to target inflation or slowdown than monetary operations alone.

Three, it is worth repeating that it is not interest rates that decide investment, but profitability. If business is in no mood to invest today, it is because it is overloaded with debt, and profitability is low. Lower rates are not going to result in any rush to invest. Any change in one of the two parameters will automatically improve the investment cycle. So we must wait for either public spending to revive growth or an upturn in the business cycle for another boom.

What North Block does or does not do impacts us more than what Mint Street does. During United Progressive Alliance-2, North Block did not do much, which is why the heavy lifting was left to D Subbarao and Raghuram Rajan. The RBI has to wade in when the finance ministry fails to do its job.