A soft landing on the horizon?

On June 8, 2023, at the conclusion of its second bi-monthly meeting for 2023-24, the MPC of the RBI announced its unanimous decision to keep the policy repo rate unchanged at 6.5 per cent. The MPC also resolved to continue with its stance of ‘withdrawal of accommodation’ with a 5-1 majority. Both these decisions, as also the corresponding voting patterns, were identical to those of the last meeting in April this year. Further, outcomes of this meeting were largely anticipated by market participants and analysts, with a few expecting a shift in the stance to ‘neutral’.

Inflation performance

The MPC’s decision to keep the policy rate unchanged for the second time despite the inflation projection for the whole of 2023-24 at 5.1 per cent being above the 4 per cent target seems to have been influenced by the sharp fall in both headline and core inflations in April, 2023 to 4.7 per cent and 5.1 per cent respectively.

The MPC would regain its credibility if retail inflation falls to 4 per cent in the coming months

However, the RBI has reiterated in this policy that a durable decline in core inflation would be critical for the headline inflation to be in alignment with the target of 4 per cent. Further, it has emphasised its resolve to achieve the target, deriving not much comfort from the fact that headline inflation is now less than the upper band of 6 per cent. In view of this, the possibility of another hike in the policy rate in this cycle cannot be ruled out.  In any case, it is too early to start talking about the start of the next easing cycle. Monetary policy-making does not happen in fits and starts.   

When the going seems to be good

After a long time, the macro-financial profile of India’s economy seems to be entering a good phase: In the RBI’s words ‘economic activity is exhibiting resilience; inflation has moderated; the current account deficit has narrowed; and foreign exchange reserves are comfortable. Fiscal consolidation is also ongoing. The Indian banking system remains stable and resilient, credit growth is robust and domestic financial markets have evolved in an orderly manner.’  Both profit and profitability of banks, including those of public sector banks are now good. Taking advantage of this, they should voluntarily shore up their regulatory capital (CRAR) to create buffers for any asset quality difficulties in future. If history is any guide, the seeds of bad times in banking are generally sown in the previous good times.     

Developmental policies

The decision to do away with the extant regulatory cap (2 per cent of aggregate deposits) on borrowing by scheduled commercial banks (SCBs) in Call and Notice Money Markets (CNMM) has been long overdue. Currently, the cap does not constrain large banks who are mostly lenders. Small-size SCBs, including those in the co-operative segment, are constrained if they need to borrow relatively large amounts in excess of the cap. Removal of the cap will likely result in an increase in the volume in CNMM, signifying more and efficient intermediation of the short-term funds available with SCBs at rates reflective of the credit risk of the borrowers, apart from the overall demand-supply position. Among other beneficial impacts, one can expect to see better alignment between MIBOR and weighted average call rate (WACR) in future.  

It is too early to start talking about the start of the next easing cycle. Monetary policy-making does not happen in fits and starts

The proposed review and rationalisation of the licensing framework for authorised persons (APs) under FEMA, 1999 has also been long overdue – the last such exercise was done was way back in 2006. Much has changed between then and now, including liberalisation under FEMA, rapid expansion of the country’s external sector and increased digitisation of cross-border payments. There has reportedly been some anomaly in giving authorised dealer (AD) licenses to few different classes of financial institutions which needs to be resolved.

However, the quintessential issue that should be addressed in this exercise is: Has the aim of the review of 2006 to provide retail forex facilities and services to residents and non-residents alike in an efficient and affordable manner been realised? The answer is perhaps in the negative, with the existence of multiple layers of inefficiencies that characterise the retail/small-ticket forex market which was expected to be the domain of Authorised Dealers - Category II (AD-II) and full-fledged money changers (FFMC). One would hope that the next round of review will address, among others, the following two issues that constrain AD-II and FFMC: one, they are not permitted to open foreign currency accounts abroad; two, their compliance cost is high. Consequently, AD-I, which are all banks get a very significant portion of the retail forex business, with adverse implications for their compliance cost. The long and short of all this is that the common man still cannot access forex facilities and services at fair and affordable cost.           

The common man still cannot access forex facilities and services at fair and affordable cost

It is more plausible now than before that the cumulative rate hike of 250 basis points since the commencement of the current tightening cycle in May last year in an off-cycle meeting of MPC is transmitting through the real economy, attenuating inflationary pressures without, however, causing any noticeable sacrifice in employment and output or stress in the financial sector. The fact that 10-year G-Sec YTM, which is now close to 7 per cent fell by about 50 basis points in the meanwhile, with the yield curve flattening quite a bit is an affirmation that inflation expectations are now well anchored.

If the CPI falls further in the coming months bringing it closer to the target of 4 per cent with or without another modest rate hike, it will be a rare soft-landing phenomenon to be witnessed in a major economy in the recent decades. years. The MPC would then be able to redeem quite a good bit of its credibility that was tarnished in the wake of the CPI inflation climbing above 6 per cent for three consecutive quarters in 2022. The regained confidence now apparent in the deeds and words of the RBI owes it all to the flexible inflation targeting framework for monetary policy setting. This framework can deliver provided both the RBI and the political leadership of the country are in agreement that tolerance of inflation is bad, both strategically and tactically.   

 (The writer is a former central banker and a consultant to the IMF)

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