Karthik Srinivasan
The Monetary Policy Committee once again unanimously decided to hold the benchmark repo rate at 6.25 percent in the first bi-monthly policy of FY18 last week. However, this time the decision was in sync with the market expectations given that the central bank’s intent had recently changed in the February to maintain a neutral stance, as compared to an accommodative one as in the past.
The decision to maintain the Cash Reserve Ratio rate while at the same time narrowing the rate corridor from +/- 50 bps to +/-25 bps is likely to partly cheer banks as it allows them room to earn higher returns on their excess liquidity or borrow funds at lower rates, thereby providing some leeway in passing on the benefit to the borrowers, if they so desire, and improve the transmission of policy actions, which is not complete.
The RBI has highlighted heightened risks to inflation on account of various factors such as uncertainty related to the upcoming monsoon, higher allowances based on the Seventh Central Pay Commission’s recommendations, global commodity price reflation and also the one-off impact of the Goods and Services Tax.
The RBI thus expects the trajectory of Consumer Price Index inflation to rise from 4.5 percent in the first half of this financial year to 5 percent in the second half, while retaining the baseline growth forecast for FY18 at 7.4 percent.
With the central bank’s current objective towards achieving the medium inflation target of 4 percent within a band of +/-2 percent while supporting growth, the likelihood of a rate cut looks rather bleak over the next few quarters.
Accordingly, the market has reacted adversely with the yields increasing steadily since the policy announcements. In the current scenario, where the liquidity is awash, the RBI has effectively increased the rates without touching the repo rate by narrowing the policy corridor. In this context, borrowers too are unlikely to see any major reduction of their borrowing rates unless banks cut the rates to improve on the transmission of policy actions done over the last year.
As the administered rates on small savings schemes were reduced by only a limited 20 bps for the quarter starting April 1, 2017 relative to the quarter starting April 1, 2016, the RBI, despite holding the policy rates this time, continued to nudge banks for cut in lending rates and the government for further cut in small savings rate to aid banks in better transmission of the earlier policy actions.
The RBI reiterated its stance to keep the systemic liquidity near neutral position but retained its flexibility by citing that it would use a mix of the policy tools available to it without quantifying the same. The plans to introduce the Standing Deposit Facility (SDF) subject to government approvals and suitably amending the RBI Act is a step towards further strengthening its arsenal in combating the systemic liquidity issues.
As in the past, in the first policy of the fiscal, the RBI also announced a slew of areas on which it would come out with detailed guidelines with an objective to strengthen the financial system.
The RBI’s reiteration to take measures to resolve the impasse of stressed assets in the banking system is significant as it is an important requisite to provide funds to the productive sectors of the economy.
The revision in the Prompt Corrective Action (PCA) framework would be an important step in this direction. Additionally, the measure to raise the capital requirements at Asset Reconstruction Companies from Rs 2 crore to Rs 100 crore is likely to ensure that only serious players enter the fray, but at the same time, their ability to recover from the assets and raise funds for fresh acquisitions will be more important given the gargantuan nature of stressed assets in the country.
The development of bond market continues to remain another key area of focus for the RBI with the measures such as allowing market participants to substitute the collaterals in term repo under Liquidity Adjustment Facility and the relaxation in the capital requirement for the bank providing partial credit enhancement.
Overall, the policy statement is a good balancing act by the RBI in terms of managing its objective of inflation targeting without sacrificing on growth while continuing to strengthen the structural framework of financial markets in the country.
The writer is Group Head, Financial Sector Ratings at ICRA Ltd
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