By Soumya Kanti Ghosh, Member, 16th Finance Commission, member, Economic Advisory Council to the PM, and Group Chief Economic Advisor, State Bank of India
As the Monetary Policy Committee’s (MPC) decision to keep the repo rate unchanged was largely anticipated, the broader market was watching out for the undertone and reading between the lines in the backdrop of the evolving situation in West Asia and its implications for growth and inflation. The economy is confronted with a supply shock, and a conscious and careful watch obviously remains the best course of action at present.
The outlook for domestic growth for FY27, at 6.9%, remains optimistic, with gradual recovery projected in the second half of the current fiscal. Elevated energy and other commodity prices along with disruptions in the Strait of Hormuz (in sync with the precarious position of shattered regional production capacities, chiefly gas and other input materials) may act as a drag on various domestic output capacities.
The supply shock is expected to be largely inflationary, but the assessment so far is that it will stay within the target band of the Reserve Bank of India (RBI) with a FY27 forecast at 4.6%. The development of El Niño conditions has been a concern, and if the adverse weather conditions coincide with a prolonged conflict the double jeopardy can be more significant in FY27.
On regulatory and development policies, the former measures have mostly focused on the banking sector. The RBI has proposed to rationalise two guidelines that affect the capital planning of banks. The first proposal is to remove the rider on deviation in incremental non-performing assets by 25% for taking quarterly profits while calculating the capital to risk-weighted assets ratio. This proposal gives considerable flexibility to banks to plough back internally.
The second proposal is to dispense with the requirement of investment fluctuation reserve (IFR)-an additional reserve under tier-II to cover losses on the non-held-to-maturity investment book. With banks already covering these losses under market risk capital charge and other income recognition provisions, IFR was a duplication in some sense. The proposal irons this out and makes risk recognition more transparent and simpler.
Also, back-of-the-envelope calculations suggest Indian commercial banks can find IFR of `35,000-40,000 crore getting freed up through a reversal (@2.5 high-frequency trading and FVTPL-AFS [fair value through profit or loss-available for sale]) portfolios of around a `14-lakh crore book, presuming a straightjacketed ~20% of bank investment book of about `70 lakh crore). This money can be used optimally and judiciously by banks to further boost Common Equity Tier-1, while possibly having a cascading effect on profit and loss account too although yields have moved up substantially last quarter.
To strengthen governance with optimal utilisation of time, it is proposed that board-level activity governed by RBI directions will be rationalised with more strategy and risk governance. That should make boards more attuned to strategy and policy formulations, a prerequisite in these tumultuous times.
On the supervision side, the RBI has further consolidated 64 Master Directions in nine functional areas, thus reducing compliance costs for banks.
On payment systems, it is proposed to dispense with the required due diligence of micro, small, and medium enterprises while onboarding on the Trade Receivables Discounting System platform. This measure is expected to further increase trading volumes on the platform and offer liquidity to the sector. Banks and regulators would, however, need to identify risks proactively.
Finally, on market development, the participant base of the term money market is proposed to be expanded to include non-bank participants-namely all India financial institutions, non-banking financial companies, and housing finance companies with enhanced limits for specified public deposits. Since banks are net lenders, the move is positive as it expands the demand for funds and deployment of intraday surplus funds. This is largely expected to have a softening impact on yields.
As emphatically iterated by the RBI governor, the rapid depreciation thrust on the INR of late is not in sync with India’s macro fundamentals and a course correction was a much-needed remedy with currency now retreating towards its implied value. As a balancing act, the governor also clarified that the present set of currency-supporting measures are not permanent as the central bank remains prudently committed to curbing higher volatility without targeting any specific level.
However, over a longer period, two things are self-evident from the present fiasco. First, the rupee will remain subservient to India’s balance-of-payments position and counterintuitive steps on this front are a sine qua non, just as liquidity measures smoothing the market ecosystem. Second, if India wishes to attract long-term patient capital (much preferred across both foreign direct investment and foreign portfolio investment routes) as also hot money, a broad set of investors would continue to explore hedging options that demand a vibrant suite of structures.
Similarly, for an emerging market, targeted forex intervention remains an absolute necessity, a testament to the central bank’s equaliser status. The question now is, can we pitch GIFT City as a credible alternative to global financial centres with fewer compliance and regulatory hurdles that dissuade the vicious loop and biases impacting a downward outlook on rupee?
Finally, we quantified the information in the policy text using natural language processing techniques and created a score using our custom-made dictionary. Out of the eight statements by the current governor since he assumed office, this is the most cautious in our opinion. But it does not mean a rate hike is imminent. The choice of words and the latent signal of the statement reflect a deep understanding of the evolving global geo-economic situation without hinting at any imminent rate hike as the regulatory gaze negotiates growth and inflationary concerns.