Sometimes, all it takes for central banks to achieve their objectives is to do things differently, rather than to do different things. Thursday’s monetary policy decision only underlines this. The decisions will cement the building blocks of a resistant Indian economy, well placed to tackle any external shocks.
The global macroeconomic environment remains uncertain. Central banks in advanced economies are continuing to raise rates amidst a sticky inflationary environment, characterised by uncertain signals from noisy job markets. This is creating its own complications, including the fast-vanishing arbitrage between jurisdictions. Recently, Fitch Ratings downgraded the US from AAA to AA+ on the back of a deterioration in the fiscal matrices over the next three years. This was reminiscent of a similar downgrade by S&P in 2011. Fitch’s downgrade was soon followed by Moody’s downgrading 10 select banks for increased use of wholesale funding.
Apart from such macro developments, events such as the escalating tech-related standoff between the US and China — new screening measures blocking future US investments in semiconductor and quantum computing, and artificial intelligence companies from operating in China — are further complicating the geopolitical landscape. The move has support from other major stakeholders in this critical supply chain like the Netherlands (whose ASML is the most critical machine manufacturer for advanced chips) and Japan. China’s faltering export/import numbers are signalling the stress. One of the biggest property developers Country Garden is defaulting on coupon payments on dollar bonds raised, triggering probably another vicious cycle reminiscent of Evergrande in the not-so-distant past.
It is against this backdrop that one must interpret the RBI’s insistence of retaining policy rates, along with keeping its stance unchanged. The central bank has revised upward its inflation projection for 2023-23 to 5.4 per cent. The large upward revision in the second quarter estimate to 6.2 per cent (earlier 5.2 per cent), due to a spike in vegetable prices, majorly led by tomatoes, is a matter of concern. However, we believe that the impact will be transitory and likely to correct with the fresh arrival of vegetables. In fact, after the jump in inflation in July and August to beyond 6.5 per cent, the fall is likely to be just as rapid from September onwards with inflation trending towards 6 per cent and below. Also, the likely decline in core inflation towards 5 per cent is a matter of great comfort, as empirical research suggests that headline inflation in India reverts to core inflation and not the other way around.
The decision to impose an incremental cash reserve ratio of 10 per cent on the increase in their net demand and time liabilities (NDTL) between May 19 and July 28 as a temporary measure to absorb excess liquidity was a surprise to the market. It is expected to impound close to Rs 1 trillion liquidity from the banking system. This could be viewed as a frontloaded measure to absorb any additional liquidity in the system because of the return of Rs 2,000 note in deposits and is likely to have an enabling impact on anchoring inflation and inflationary expectations.
The outlook on growth looks evenly balanced. We believe that the RBI’s projection of 6.5 per cent is likely to be overshot. More importantly, the Indian economy now has a healthy and mature banking ecosystem. And with core inflation moderating, notwithstanding the embedded volatility in vegetable/groceries, Mint Street is optimistic of renewed credit appetite with manufacturing capacity utilisation now running above its long-term trend.
The development and regulatory policies include a range of announcements which show continuity in approach. RBI has now decided to revise the extant regulations issued in June 2019 and put in place a comprehensive, risk-based framework for the administration of financial benchmarks. Reforming the financial benchmarks in a bid to enhance governance and oversight arrangements, and transparency is a welcome move. The revisions in the regulatory framework of NBFC-IDF are a good move to widen the source of finances to the infrastructure sector.
As bank product pricing has increasingly migrated to an EBLR regime (external benchmark lending rate), there was a need to bring more rule-based practices in floating rate resets and EMIs. Keeping this in mind, RBI envisages that lenders should clearly communicate with the borrowers for resetting the tenor and/or EMI, provide options for switching to fixed-rate loans or on foreclosure of loans. This brings more customer-centricity to product design and allows for informed customer decisions making.
The announcements on the payment systems side have become routine. But there are some novel proposals on the table. RBI has suggested launching an innovative payment mode — the “Conversational Payments” on UPI that will enable users to engage in a conversation with an AI-powered system to initiate and complete transactions in a safe and secure environment. The proposal largely widens the ease-of-use feature of the UPI by leveraging AI technology.
The proposal to roll out offline payment systems was already in the public domain. The UPI-Lite will now have an offline transaction facility using near-field communication (NFC) technology. The proposal is expected to further enhance the adoption of UPI for small ticket transactions. Further, the lower limit of Rs 200 per transaction has been increased to Rs 500 for small-value digital payments in offline mode including for National Common Mobility Card (NCMC) and UPI Lite.
Lastly, in a significant move, the central bank has proposed to create a Digital Public Tech Platform based on its pilot experiment in KCC. The initial success of the project has made it ready for a pan-India launch. The idea is to connect banks and final borrowers through an open platform. The move assumes great ramifications as a need-based and time-bound credit dispensation can greatly enhance domestic consumer demand. As the platform can host and connect multiple financial sector entities, it should usher in better price/rate discovery eventually while ensuring stricter adherence to rules by all stakeholders.
The writer is Group Chief Economic Advisor, State Bank of India. Views are personal
