The 25 basis points (bps) rate cut was widely anticipated. The good thing was the return of the Reserve Bank of India (RBI) to conventional wisdom of a rate change in multiples of 25bps.
In fact, RBI has smartly used communication as a policy rather than the policy statement being the vehicle for communication. With the use of sentences like “MPC decided to continue with an accommodative stance as long as it is necessary to revive growth, while ensuring that inflation remains within the target", we find it similar to Fed statements of indicating to the markets of keeping the federal funds rate low for a longer period than priced in by the markets. We hope the markets, specifically debt, take a cue from this second-generation policy signals and notably the yields soften from the current level.
Even though RBI has clearly emphasized more rate cuts, the efficacy of such is questionable against an elevated household leverage, deteriorating company fundamentals (upgrade to downgrade ratio has now halved) and significant weak demand. For example, rating upgrade to downgrade ratio has deteriorated to 0.41 in H1FY20 from 0.85 in H1FY19. The number of downgrades in H1FY20 grew by 66% vis-à-vis a 20% de-growth for the number of upgrades. The pace of downgrades has been increasing and hence, that explains the sharp fall in upgrade/downgrade ratio in H1FY20 versus H1FY19. Similarly, financial flows to the commercial sector in H1FY20 are significantly lower than H1FY19 due to a decline in funding from banks and non-bank sources. Interestingly, in H1FY19 despite a rising interest scenario, credit had expanded by over ₹1.65 trillion but contracted by ₹93,700 crore in H1FY20, even as we are in an aggressive rate cut cycle. This indicates credit risk aversion continues to play centre stage, particularly for the non-bank sector.
Even though the Centre has done a remarkable job in maintaining fiscal consolidation, we are now increasingly concerned about the fiscal position of the states. With ₹6.24 trillion total gross borrowings for FY20 and ₹3.95 trillion gross borrowings already done, states are expected to borrow ₹2.29 trillion in Q4.
While the policy announcement was along expected lines, the development and regulatory policy measure covered a wide canvas. RBI’s decision to increase the household income limit for borrowers of NBFCs and MFIs is welcome, and will enhance credit delivery to a larger customer base at the bottom of the pyramid. There is an attempt to boost the domestic forex derivative market considering the pickup in non-deliverable forward activity in the rupee. RBI has decided to allow domestic banks to offer foreign exchange prices to non-residents on a 24-hour basis, and this heralds a paradigm shift. More clarity is needed, going forward, to crystallize the know-your-customer requirements for off-shore entities as also their tax implications.