The Reserve Bank?s monetary policy statement announced on Tuesday has a three-pronged objective of containing inflation and anchoring inflationary expectations, sustaining growth and ensuring financial stability, and managing liquidity for better monetary transmission.
Inflation has emerged as a major fault line in India?s economic structure, which is not conducive to the country?s long-term growth prospects. The RBI stance has, therefore, clearly shifted into inflation control mode and continuing its path of steady tightening.
RBI has increased the policy rates along with measures to streamline the operating procedure of monetary policy. Accordingly, it has hiked the key policy rates to 7.25% and 6.25% respectively, while keeping the CRR and bank rate unchanged. Consequently, cost of funds for banks is expected to rise, with upward bias on interest rates.
RBI has introduced some far reaching changes impacting both the liability and asset side of bank balance sheets which will affect spreads and profitability. Increase in provisioning, higher interest rate on savings bank deposits, capping bank investment in liquid mutual funds at 10% are all measures that will impact bank bottom lines. Therefore, banks will need to focus on efficiency, leveraging technology and cost cutting.
Inclusion of loans to MFIs that meet RBI regulations under banks? priority sector lending and pushing branch expansion in tier 5 and tier 6 cities are clearly aimed at driving financial inclusion. Extension of the period for short sale in G-sec from five days to three months will provide stability to the market as players will be able to take a somewhat longer view.
Streamlining of the operating procedure of monetary policy including adopting the repo rate as the single operating rate, introduction of a new marginal standing facility and fixing the LAF corridor will help improve the transmission process. In our view, RBI has been front loading the policy rate hikes given the time lag in policy transmission and its focus has shifted from downside growth risks to upside inflation risks.
There is some upward pressure on interest rates and banks may pass on the increase in cost burden and raise rates. As the output gap is seen narrowing and the economy needs to increase capacity, our view is that given the continuing demand for credit reflected in credit growth outstripping deposit growth, a small increase in lending rates may not prove disruptive.
Overall, an excellent policy balancing the requirements of the different sectors of the economy. The overarching theme is inflation control along with sustaining growth, channelling credit for productive purposes, ensuring financial stability and inclusion.