Lower rate cuts and NPAs...

Yesterday the RBI reduced repo rates, by 25 basis points, as expected by the economists and analysts and maintained a neutral stance as before, i.e. data determined calls for further rate adjustments, if inflation remains benign while highlighting a 4% inflation target for the medium term which still releases a lot of scope of further rate cuts if growth and growth expectations remain low. However, the government and the public demanded significant rate cut to push stalled investment, partly due to higher borrowing cost and partly due to high debt and NPAs which has reduced demand and growth, of companies and banks, borrowers are unable to borrow and banks are reluctant to lend due to less capital and reserves. Nevertheless, a rate cut might be important to lower the borrowing cost and adjust margins, for both, but reviving investment demand is equally important to increase profits and margins. However, under the problem of NPAs and low demand, the RBI might reduce CRR for the troubled banks or could buy bonds from banks, banks have a better credibility than corporate, and some private banks have already used external borrowing through masala bonds to recapitalize themselves. Higher NPAs may be a reason for the banks to not feel money-supply and increase monetary policy transmission, the RBI might finance them with new money or using the dividend it has earned for the government of INDIA. The government must also utilize this money purpose fully… hope it has not been used yet… Or the government of INDIA too can borrow from the central bank using bonds which would safe because the government may pass resolution to dilute its debt in extreme cases by mint. The NPAs are a big drag on growth which public spending would increase it indirectly. Reviving demand directly by bailing out banks directly is also not out of question, because it has all happened under tight regulation of the RBI and the government. There could be a wide range of solutions to increase demand, but increasing investment demand is above all to increase employment. The commercial banks too could try to borrow and recapitalize themselves because they are hit by bad loans and deficit in balance sheet which could be increased by increasing demand for loans. There is little doubt that the ability to lend more at lower cost would increase banks’ profits. However, lower demand and lower inflation and higher unemployment has increased real interest rate by 4.5 % which is also likely to increase savings and excess capacity. The lower real interest rate would also help reduce excess capacity and increase investment employment and demand and supply and growth. Higher real interest rate would increase savings at the cost of consumption and investment demand and growth; people are saving more due to lower prices and also due to remonetization and compulsion to deposit money in banks and less spending which were also responsible for excess capacity and more savings. The regulation on deposits by the RBI during remonetization has also resulted lower rate transmission by the commercial banks… Notwithstanding, banks reduced home loan rate once by 1%, but, it had little effect on the investment demand because of lower real estate prices and the same NPAs have reduced the economic activity in the labour intensive sector…. NPAs remain a major cutback on the demand and growth and infusing more liquidity or recapitalization are likely to smoothen or sustain the growth path and path expectations …