Moneycontrol Pro Panorama | Rupee’s tantrums throw fresh challenges to MPC

For the newly constituted MPC, the free-falling rupee presents a significant challenge.

Dear Reader,

On Tuesday, the RBI reshuffled the portfolios of three remaining deputy governors of the central bank after the term of Michael Patra, who oversaw the monetary policy department, expired yesterday. Patra's exit shortly after that of former governor Shaktikanta Das, marks the end of an era at the RBI -- an era characterised by unrelenting vigil against inflation. In other words, two major anti-inflation voices within the MPC have exited the scene.

The stance of new members will be clear in the February review. Post Patra’s exit, the crucial monetary policy department will be handled by Deputy Governor M Rajeshwar Rao. This is a typical exercise in RBI which always has four deputy governors. When Patra’s replacement joins, the RBI will once again reshuffle the portfolios.

Meanwhile, for the newly constituted MPC, the free-falling rupee presents a significant challenge. This is because a depreciating rupee increases the cost of imports, leading to imported inflation. As Aditi Gupta, Economist at Bank of Baroda, says in this story, sectors heavily dependent on imported raw materials are likely to witness escalation in costs due to higher input prices, impacting margins. This can also translate into higher prices for consumers, which will put a strain on spending and consumption.

To be sure, India’s retail inflation has been on the downward path for the past few months due to easing food inflation. The CPI inflation declined to a four-month low of 5.22 percent in December as compared to 5.48 percent in the previous month. The rupee has lost big this year against the US dollar and fell past the 86-mark even as the central bank defended the rupee. The widely expected rate cut in the February policy may be put on hold if the rupee continues to decline as lower interest rates could result in capital flight further weakening the currency.

It's not just the rupee fall, the tight liquidity too has made the central bank’s policy task even tougher ahead of the February policy review. The banking system has received liquidity worth Rs 1.16 lakh crore after the CRR cut by RBI. The liquidity was infused in two tranches on December 14 and December 28. But this proved to be inadequate because of heavy outflows due to advance tax and goods and services tax payments. The banking system witnessed outflows of over Rs 3 lakh crore on the back of tax payments in recent weeks. Currently, the banking system is running a deficit of Rs 2.1 lakh crore.

At the industry level, tight banking system liquidity has forced many banks to increase their deposit rates. These include SBI, HDFC Bank and IDBI Bank, among others. The central bank typically prefers to keep the system liquidity tight for effective monetary policy transmission. But too much of tightness in liquidity can push up short term interest rates and hence can have a rippling effect across the banking system when banks pass on the high rates down to customers.

In today’s MC Pro, this piece explains why small lenders may not have a good year in 2025. The piece explains microlenders may have to worry beyond the funding squeeze; their asset quality showed deterioration in 2024 and there are regulatory concerns on lending discipline. Also, Sashi Sivramkrishna has an interesting take on the 90-hour workweek debate.

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