MPC Can’t Ignore Financial Stability Concerns, Says Nomura’s Sonal Varma

India's monetary policy committee must take into account the liquidity crunch being faced by a section of non-bank lenders, which is impeding the flow of credit to the Indian economy. That's according to Sonal Varma, Nomura's chief economist for India and Asia ex-Japan.

While the formal mandate of the committee extends only to inflation and growth, financial stability plays a key role in both and should be taken on-board while deciding the future course of monetary policy action, Varma said.

Speaking ahead of Thursday's monetary policy review, Varma said that the committee is likely to cut interest rates for a sixth time, bringing down the benchmark repo rate by 25 basis points to 4.9 percent. The lower rates, however, will only have a marginal impact in shoring up growth in the economy. GDP growth fell to 4.5 percent in the second quarter of 2019-20, the lowest since 2013.

The slowdown, in the last two quarters, has worsened due to the weak flow of credit and must be a part of the MPC's discussions, Varma said.

“Financial stability, ultimately whether it is there or not in the inflation-targeting document, feeds into the macro-economic outlook which the monetary policy committee has to take on board,” she said in a conversation with BloombergQuint.

Along with the flow of credit, the cost of credit also remains elevated for a large section of borrowers. Varma said while the lower policy rates have seeped through to the country's money markets, transmission remains incomplete across credit channels in the banking system.

“The have-nots still continue to face issues when it comes to new funding or the cost of funding,” Varma told BloombergQuint in an interview. “We now need to think beyond monetary policy in terms of what we need to do to address these transmission issues.”

Lending by the struggling non-bank sector contracted for the second straight quarter. Loans sanctioned by non-banking financial companies declined 34 percent year-on-year in the quarter ended September to Rs 1.95 lakh crore, according to data from industry body Finance Industry Development Council. That came after a 15 percent contraction in the previous three months. Non-bank lenders have found it difficult to raise funds after the collapse of Infrastructure Leasing & Financial Services Ltd. last year.

On GDP Growth

Nomura said the GDP growth falling to over a six-year low of 4.5 percent indicated that the underlying private demand remained weak. India is likely to deliver another quarter of growth lower than 5 percent as there is no “big change” in the reasons for which the economy has slowed down, Varma said.

The only thing we are banking on seems to be that the base effects [for GDP growth] are positive. I don't think that's a good enough reason. Therefore, the risk of growth remaining  below 5 percent are very real and it will be very difficult for growth in FY20 to cross 5 percent.  

Watch| MPC needs to tackle credit conditions in the Indian financial system, says Nomura's Varma.