New RBI Guv debuts with a rate cut & ‘appropriate’ liquidity; delivers a correct combo of change & continuity

Despite being less than 60 days into the job, the governor stuck to the age-old RBI script when questioned on the RBI's FX market intervention.

The RBI MPC delivered a rate cut as expected and the governor in his statement promised “sufficient” liquidity. What stood out was the restrained dovishness of the policy – admitting to the scope for a rate cut now, given the fall in inflation and growth, but refusing to guide any more dovishness or restrictiveness. For a debut effort by the 2-month-old governor, the policy deserves praise on many counts:

1. The statement explained that growth declining from FY24 levels and the likelihood of inflation remaining below 4.5% in 2025, gives the MPC space to be “less restrictive…at the current juncture”, but immediately added that “the MPC will decide for each of its future meetings based on a fresh assessment of the macroeconomic outlook.” Considering that weather and supply dislocations can push up inflation, the RBI was right not to assure continued dovishness. For the same reason, retaining the neutral stance was appropriate.

2. The governor also did not over-promise or under-deliver on liquidity. “The Reserve Bank is committed to providing sufficient system liquidity,” he said, adding “We will continue to monitor the evolving liquidity and financial market conditions and proactively take appropriate measures to ensure orderly liquidity conditions. The preference for promising “appropriate” rather than “ample” or “surplus” liquidity is justified partly because global uncertainties may warrant caution on the currency front. A promise of surplus liquidity can be an invitation to speculators to borrow money cheaply to short the rupee.

3. The governor postponing the stricter liquidity coverage rules and the expected-loss method of accounting to beyond March 2026, was sensible. Such structural reforms should not be embarked upon when growth is slowing and the external sector and the exchange rate are under strain from capital outflows. Such reforms are meant to be ushered in periods of high growth. The governor said the RBI will be conscious of the cost to be paid in terms of efficiency in exchange for gains on financial stability. One would like to think that such trade-offs are always weighed by the RBI. To be fair to the previous RBI leadership, the draft LCR and ECL rules were proposed when growth was steaming at over 8 in FY24.

4. The statement announced that the RBI will implement "bank.in" as an exclusive internet domain for Indian banks. Such a domain will help the lay consumer identify pesky and fraudulent emails. To be sure the RBI must have been working on such a plan for a while, but it is possible the new governor, with his computer science background, may have urged the RBI IT team to speed up the launch of this domain. Full marks to RBI and the governor.

5. The RBI in the policy announced the launch of forward contracts in government securities. This is a much-needed product for insurance and pension companies to manage their interest rate risk across cycles. Separately it has also allowed non-bank brokers, registered with SEBI to trade on the NDS-OM, the electronic order-matching trading system for g-secs. Both these steps deepen the bond markets incrementally.

6. The governor's call to banks to participate more in the call market was welcome. In his statement, he said," It has been observed that some banks are reluctant to on-lend in the uncollateralised call money market; instead, they are passively parking funds with the Reserve Bank. We urge the banks to actively trade among themselves in the uncollateralised call money market to make it deeper and vibrant for better signal extraction from the weighted average call money rate (WACR)." This call was much needed. RBI inspectors in the past had pulled up banks for borrowing from the repo and lending in the call market on the same day. Thereafter senior RBI executives have backtracked and have clarified to banks that RBI is not averse to banks borrowing from the RBI's repo window and lending it on the same day via the call market. But bankers have remained cautious preventing efficient price discovery in the call market. A clarion call from the governor in his policy statement may put all fears to rest and energise the call market.

7. Finally, the new governor's praise for the flexible inflation targeting framework was timely. The 2024 economic survey had contained a box item questioning whether food prices should be included in the RBI's inflation target since food prices are usually impacted by supply problems and are not amenable to interest rates. This has created doubts in some quarters about whether the RBI's flexible inflation targeting framework will be continued in its present form. The governor's generous praise of the framework removes those doubts.

8. Despite being less than 60 days into the job, the governor stuck to the age-old RBI script when questioned on the RBI's FX market intervention. "The RBI intervenes only to smooth volatilities and doesn't have any market level in mind", came the practised reply- a response one has heard from Bimal Jalan through Reddy to Subbarao to Rajan, Patel and Das. That reply from Governor Malhotra was a sign he had arrived as a Mint Street maven.

Where did the policy open itself up to criticism? Some bankers and economists opined the RBI should have cut the CRR or been more forthright about assuring liquidity since rate cuts won't get passed on in the current tight liquidity milieu. This group also expected a stance change. They have a point. Deposit rates are unlikely to fall for a quarter or more, the SBi Chairman told CNBCTV18. And if deposit rates don't fall, lending rates won't fall for the system as a whole. Rates falling two quarters later can weigh on growth. On the other hand, any over-promising of liquidity or dovishness given the sudden attacks on the currency would be dangerous. The RBI governor's restrained promise of "proactive adequate liquidity seems a more responsible choice. As always one will know only a year from now if this limited dovishness was appropriate.

Some economists find the RBI's FY26 growth forecast at 6.7% is a tad too ambitious. A CNBCTV18 poll last week had thrown up an average of 6.5% as the GDP forecast for FY26. The RBI's 6.7% is not way off. The inflation forecasts at 4.2% may also be a tad too optimistic, given the fall in the currency that brings with it imported inflation, given the vagaries of weather and given the huge tax cuts which can lead to too much money chasing too few veggies and pushing up the CPI inflation. But here again, most economists at worst see CPI inflation at 4.3% or 4.4% in FY26.

All told the new governor's maiden effort merits an A-plus.