By Suganya Balakumar
A recent report by the Bank of America Merrill Lynch (BofAML), the global financial services major, stated that Lending rate cuts hold the key to recovery. They would push up demand, put idle factories to work, and spark off investment when capacity is exhausted, in our view. According to the report, any structural reform takes 5-10 years to be reflected in the growth rate of the economy. The report mentioned that cutting down lending rates would boost the economy by stimulating investments and increasing demand.
Slips in growth and investment
In a similar report in the first week of September, BofAML analysed the slip in investment from 29.2 percent to 27.5 percent in June 2016. This occurred due to the dampening of high lending demands and the sustaining of excess capacity. Following the GST rollout and the weakening of manufacturing activities, Indias growth slipped to 5.7 percent in the April-June quarter. The Gross Value Added (GVA) growth was 5.6 percent. This was mainly due to the demonetisation shock and the GST destocking. BofAML stated, growth is stuck at an anaemic 5 percent (in old GDP series), well below our estimated 7 percent potential, as high real lending rates are constricting domestic demand in a long global recession. Due to the low growth rates in the April-June quarter, there are higher chances for a rate cut in the December policy review meeting. Recently, RBI reduced the repo rate by 0.25 percent to 6 percent in August, due to falling prices and low forecasts of inflation, which brought policy rates to a six-and-a-half-year low.
Recommendations for reform
One of the major recommendations of the BofAML report is that banks should cut lending rates by 25 basis points (bps) before the October-March busy season sets in, which would help revive demand and spark up investments. Two policy review meets are scheduled on October 3rd and December 6th. The report mentioned that the RBI is expected to cut the policy rate by 25 bps in the policy review meet on December 6, since the RBI expects inflation to normalise and stay within the 2-6 percent range. This expected policy cut would signal a lower interest rate regime. In the previous report, BofAML stated that one of the major factors for a possible reduction in lending rates is the high level of liquidity in banks. Demonetisation has temporarily increased the banks liquidity, with money shifting from the public’s hands to bank deposits.
Lending rate cuts
It was also the RBI Governor Urjit Patels view that banks should lower the lending rates by 25 bps before the industrial ‘busy’ season starts in October. Any delays would result in a slack in the April quarter. The lending rate cut is the key to recovery. Prime Minister Narendra Modi had also indicated a strong preference for lending-rate cuts in his December 30, 2016, speech. Therefore, based on the BofAML reports, we could expect that the RBI Monetary Policy Committee would cut rates by 25 bps in December, on account of a weak growth rate.
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