– By Karthik Srinivasan
In line with expectations, the Reserve Bank of India (RBI)’s Monetary Policy Committee (MPC) once again unanimously refrained from changing the repo rate, while retaining its policy stance at “withdrawal of accommodation”, with a 5:1 vote. While the inflation forecasts were retained, there was a sharp upward revision in the MPC’s growth forecasts for H2 FY2024. This optimism followed from the Q2 FY2024 GDP print, which, at 7.6 per cent, was significantly higher than the MPC’s forecast of 6.5 per cent.
On the inflation front, the MPC has kept the CPI inflation projections for Q3 and Q4 FY2024 unchanged at 5.6 per cent and 5.2 per cent, respectively, thereby maintaining its full-year FY2024 estimate at 5.4 per cent. Thereafter, it expects the CPI inflation to print at 5.2 per cent in Q1 FY2025, witness a base-led cooling to 4.0 per cent in Q2 FY2025 and rise to 4.7 per cent in Q3 FY2025. These estimates would however remain contingent on the weather conditions next year and the crude oil prices.
While a status quo was expected on the rate front, however, the policy announcements were eagerly awaited to see if the RBI will announce any follow-up actions after its decision last month in November, to hike risk-weights on certain consumer loans and loans given by banks to non-banking financial companies (NBFCs). This announcement will slow down the credit growth to these segments and has also effectively hiked the borrowing cost for these customers, without any action on the policy rates.
Similar action by the RBI to implement the incremental cash-reserve ratio (ICRR) in August 2023 policy announcement, sucked out liquidity in the banking system and a spike in overnight call money rates and rise in borrowing costs through short-term instruments, such as commercial paper. This action was followed up by the RBI’s commentary in its October 2023 policy, whereby it indicated that it may undertake open market operations (OMOs) sales of the government securities to suck out any durable liquidity surpluses, which led to increase in borrowing costs through long-term instruments like bonds and debentures.
With a fifth consecutive status quo policy announcement since April 2023, and the moderation in inflation outlook, we expect that the RBI’s action to manage credit growth and interest rates will continue to remain outside the monetary policy statement, before the MPC starts the rate cut cycle.
Further, since the last policy statement in October 2023, the bond yields in developed economies have cooled off, and the Governor’s statement to be mindful of the risks of overtightening amid risks emerging from global spillovers as well as geopolitical tensions, provided confidence to bond markets that the rate hikes cycle is almost over. However, at the same time, the OMOs sales, which played a spoiler for long-term bond yields in previous policy was not completely ruled out, though the Governor said that it may not be required in near-term. As a result, the yield on benchmark 10-year government bonds remained stable at 7.23-7.25 per cent.
In a separate announcement, the RBI allowed reversal of the marginal standby facility (MSF) and special deposit facility (SDF) on a daily basis over the weekends and holidays. The MSF is used to avail funds and SDF is used to deploy surplus funds with RBI by banks. Given the 24 X 7 fund transfer facility available for customers, the banks face challenges on liquidity management over the weekend, when inter-bank markets are closed. Hence, as a matter of prudence they end up borrowing three-day funds in the inter-bank market and MSF window over the weekend. Similarly, banks with surplus liquidity end up locking the funds for three days under SDF over the weekend. With this proposal, we expect the volatility in call money rates to reduce and the extent of balances used in MSF and SDF facilities over the weekend also to go down. However, given the overall tight liquidity in the banking system, we do not expect the call money rates to decline substantially. This will also lead to some savings in interest costs for banks who end up borrowing in MSF and also depositing in SDF over the weekend.
The RBI also proposed to review the connected lending framework. The connected parties may go beyond the common directors or where the managers and their relatives may have relationships with the borrower. Further, connected lending could also involve lending arrangements among lenders which may involve moral hazards, such as evergreening of loan exposures. Hence the proposal to review the framework is positive for the transparency and long-term health of the financial sector.
(Karthik Srinivasan is the Senior Vice President, Group Head – Financial Sector Ratings at ICRA Ltd.)
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