By Soumya Kanti Ghosh
The first deliberations of the new Monetary Policy Committee (MPC), under a new stewardship of the Reserve Bank of India (RBI), has the clear imprint of a technocrat batting for less rules, more reforms ushering in a troika of stability, consumer protection, and economic interests. The statement has more than met market expectations, delivering tangible as also intangible policy blueprints. The hallmark of the policy statement and the subsequent press brief is a clear communication to the market in terms of defined objectives.
Specifically, the policy has underlined the importance of current flexible inflation targeting (FIT) in unambiguous terms. As the policy has clearly communicated a major advantage of FIT is that it combines elements of both “rules” and “discretion” in monetary policy. This “constrained discretion” framework combines two distinct elements: a precise numerical target for inflation in the medium term, and a response to economic shocks in the short term. Rather than focusing on always achieving the target, the approach has emphasised achieving the target over the medium term — typically over a two- to three-years horizon. Thus, inflation targeting provides a framework within which the central bank has the discretion to react to shocks. Because of the medium-term focus of inflation targeting, the RBI need not feel compelled to do whatever it takes to meet targets on a period-by-period basis. Clearly, the bottom line is: as inflation is supposed to trend down in FY26, the rate cut cycle is likely to continue.
The spirit of such discretionary-based regulation is clearly evident with the RBI emphasising that the draft liquidity coverage ratio, expected credit loss, and provisioning norms will be delayed. This emphasis thus adheres to the spirit of the regulation, but the RBI wants to use all available information in the future to take an appropriate call.
We believe that this discretionary-based approach is more relevant for emerging economies like India looking to develop their financial markets by opening them up to more innovation and risk-taking to leverage the opportunities in a de-globalising world. Such actions reduce frictions optimally and can help each stakeholder to maximise gains, without harming the other.
Coming back to the policy, along expected lines the RBI MPC decided to cut the policy rate by 25 basis points (bps), further strengthening the vibrancy and resilience of the ecosystem, building upon the announcements in the recent Budget and emanating trends seen elsewhere on the growth-inflation front. Best still, the MPC unanimously decided to cut the rate while retaining the policy stance as neutral, and this harmonisation of divergence is an important signal indeed. In the MPC’s assessment, global growth is below the historical average even though high-frequency indicators suggest resilience amid continued expansion in trade. The external sector continues to have challenges with slower pace of disinflation, lingering geopolitical tensions, and policy uncertainties and the present decision, as also the trajectory envisaged, should be seen in this context.
The GDP growth for FY26 is expected at 6.7%. Inflation is expected to average 4.2% in FY26. An important cog in the strategy could be global crude oil prices where US-led initiatives are destined to keep upward volatility in check, softening the blunt drag on our import-induced exogenous shocks. In all, the monetary policy and fiscal policy have both aligned to cushion growth and any disruption due to trade wars.
On the regulatory and development policy front, the RBI has continued its focus on strengthening the resilience and vibrancy of financial markets and cybersecurity. The introduction of forward contracts is a positive step as it brings better price discovery and liquidity, especially as the 2023 draft policy envisages scheduled commercial banks (except small finance banks/regional rural banks, payment banks, local area banks) and standalone primary dealers as market makers and others as users of such derivatives contracts to proliferate diverse views on interest rate trends. Access of Securities and Exchange Board of India-registered non-bank brokers to the NDS-OM platform is expected to improve price discovery on-time while widening the user base.
Interestingly, the governor’s take on select banks not optimally participating in the uncollateralised call money market, instead taking the last/least envisaged recourse of parking surplus funds with the regulator itself, calls for revisiting the usefulness of the call money market as a signal of the market-determined target rate. In principle, the RBI targets the weighted average call rate; however, the NDS call platform sees low volumes. Over the years, the share of call money has declined significantly (currently around 2% compared to 69% share of the TREP [treasury bills repurpose] market and the remaining 29% of market repo) with market participants. This has been especially stressful for primary dealers who frequently resort to call money borrowing, in the absence of longer VRR (variable repo rate) windows. Lending on the call platform also requires banks to have counterparty limits in place as the exposure is not on the Clearing Corporation of India Ltd. While the nudge from the RBI is expected to improve the volumes on NDS-call, it also needs to be seen if the surplus funds parked in the standing deposit facility are due to inflows coming during post-market hours. Generally, liquidity with banks have remained tight and they are seen borrowing on the TREPS/CROMS platform during the day.
In principle, liquidity management per se still has some operational challenges like improving the market microstructure, a proper indicator of liquidity tightness in the system, and most importantly maintaining a delicate balance between the effective mix of durable and transient liquidity injection/withdrawal.
The RBI has constituted a working group to comprehensively review trading and settlement timings across market segments. With a synchronised, 24×7 transaction pattern evolving across market/asset classes there is a felt need to rationalise and harmonise the timings of various market segments.
By mandating a specific domain for banks and non-banking financial companies and allowing double authentication for cross-border card-not-present transactions, the RBI also addressed the security aspect of digital banking to ensure trust.
In a nutshell, the policy announcements are nuanced, flexible, and gives a clear communication for the future — reemphasising Ben Bernanke, the former chair of the Federal Reserve who once observed that “monetary policy is 98% talk and only 2% action”. Yes, indeed!
The writer is member, 16th Finance Commission, and group chief economic advisor, State Bank of India.
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