By Soumya Kanti Ghosh , Member, 16th Finance Commission, EAC-PM, and group chief economic advisor, State Bank of India
The unanimous Monetary Policy Committee (MPC) decision to hold rates is reminiscent of the term “constrained policy discretion” in economic literature. While it is used more often to indicate the flexible part of inflation targeting as followed by central banks worldwide, we believe the Reserve Bank of India (RBI) has judiciously moved beyond the rate cacophony in the current policy and used discretion beyond chiselling the monetary policy alone.
The slew of regulatory reforms announced by the RBI add an exotic flavour to the financial markets, enhancing the much-sought ease of doing business, the calibrated loosening of select areas hinting at the maturity of our ecosystem lending value to the financial system’s core competencies.
At the time of writing, the US economy has officially slipped into shutdown. Looking through the shadows of recent events and assertive tone of various stakeholders, it could be more painful than the last instance in December 2018 that had stretched for 35 days. Thus, data quality could be under immense scrutiny in the coming days.
Basis MPC, real GDP growth for FY26 is now projected at 6.8% with risks evenly balanced. Further, a positive monsoon and comfortable stocking of grains have ensured a benign inflationary trajectory. FY26 inflation projections are now at 2.6%, witnessing a 160-basis point downward revision from the April policy. FY27 inflation projections are at 4.5%. However, we believe both FY26 and FY27 inflation numbers are likely to undershoot further. Even the position on liquidity and current account look comfortable, and steps taken earlier on the cash reserve ratio are expected to bankroll the system in the coming quarter.
Against the uncertainty plaguing global financial markets and economies themselves, the MPC’s choice of holding rates seems logical from a regulatory angle. However, given the pivotal role of monetary policy communication in guiding expectations, the perceived reaction function and the clarity of communication assume utmost importance.
In fact, by this logic, uncertainty is an inherent feature of every policy cycle. In December, the countdown to Budget starts; in February the Budget is presented and provides a signal on the fiscal path. In April, the evolution of demand and fiscal impulses could provide added information; in June, the monsoon is about to set in. In August and October, the progress of the monsoon shapes food prices; and throughout, global financial conditions remain fraught. While these factors continually shift the outlook, the MPC must still take decisions based on the best available information. From that standpoint, a rate cut was a plausible outcome amid all the noise. But the communication was unequivocal in terms of the possibility of further easing, though unclear on the timing.
Among reforms proposed by the RBI, the ones facilitating resilience and competitiveness of Indian banks stand out. With the regulator agreeing in principle to expand the scope of capital market lending where an enabling framework for Indian banks to finance acquisitions by Indian corporates is on the cards, it unlocks some value in the corporate funding life cycle (basis FY24 M&A activities, Indian banks could be looking at least a `1.20-lakh crore credit growth, besides decent fee-based income).
Presently, foreign entities are active in M&A funding through dollar loans, which is also adding to our external debt. If Indian banks actively participate in this space, this will help check the build-up of external debt and reduce external vulnerability.
The expected credit loss framework of provisioning with proposed prudential floors should anchor our banks’ quest to adapt and adopt best underwriting practices. Together they should result in better pricing for credit to different borrower classes. Since the timeline is quite extensive (beginning April 2027, with a glide path till March 31, 2031) to smooth the one-time impact, if any, of higher provisioning on their existing books, the move should strengthen the sector’s systemic resilience.
Postulating the Basel III Endgame in full by making the revised Basel III capital adequacy norms effective for commercial banks from April 2027 aims to mainly address excessive variability of risk-weighted assets across banks.
Importantly, the regulator has proposed to withdraw the framework introduced in 2016 that disincentivised lending by banks to specified large borrowers (with credit limit from banking system of `10,000 crore and above). This could boost corporate bank credit. Incremental corporate borrowing, including bond, commercial papers (CPs), and external commercial borrowings, was around Rs 30 lakh crore in FY25. If we assume 10-15% may come back it has a potential for banks to lend another Rs 3-4.5 lakh crore towards meeting corporate demands, subject to pricing of risks.
The introduction of risk-based deposit insurance premium against the currently applicable flat rate ensures a revised premium for scheduled commercial banks. It could save Rs 1,300-1,500 crore per annum, ensuring banks that are “sound” pay a lower premium.
As significant participation of retail investors ushers in an equity cult driving sustainable wealth creation for younger generations, the enhanced limits on bank lending against shares signal unlocking of value for both lenders and equity holders.
The proposed wider use of special vostro account balances by making them eligible for investment in corporate bonds and CPs, apart from T-Bills, raises the attractiveness of these short-term overseas funds.
To further strengthen exports and enhance ease of doing business, the time period for repatriation from foreign currency accounts of Indian exporters in IFSC is extended from one to three months, a welcome initiative that will liberalise FX management; the period of forex outlay for merchanting trade transactions is increased from four months to six months, the increase in payment outlay offering a cushion and increased flexibility; the process of reconciliation of outstanding entries related to exports and imports in the respective reporting portals is also simplified.
The RBI also plans to tighten the internal ombudsman framework to ensure banks and financial institutions handle complaints more effectively. Efforts to further internationalise the rupee are welcome. Reference rates in addition to USD, EUR, GBP, and JPY, against INR, will now be published, encouraging banks to quote directly in a larger set of currency pairs, thus eliminating the need for multiple currency conversions, and making trade more efficient.