The monetary policy announced on 05th December was largely along expected lines. A lot has been said about the repo rates but that was held at 6.50% along expected lines. This ensured that the reverse repo rate stayed at 6.25% while the bank rate stayed at 6.75%. While the policy has downsized its inflation expectations for the next few months, it still believes that the inflation risk is elevated due to oil price uncertainty. Also, the RBI is of the view that the full impact of food inflation may not be visible as yet. Now for the 3 issues…
Why calibrated tightening
With a sharp fall in inflation, the markets were expecting a shift in the monetary stance from “Calibrated Tightening” to Neutral. However, the MPC voted 5:1 in favor of retaining the monetary stance. The RBI has been driven by two factors. Firstly, the policy meeting came just a day ahead of the OPEC meet, which was to decide on supply cuts by the OPEC and friendly nations. MPC expected any cut of more than 1 million bpd to impact prices of crude oil. Secondly, the rupee was yet to stabilize. CAD has come in at a multi-year high of 2.9% and that would make the rupee a lot more vulnerable. RBI may have to hike interest rates to check the rupee fall. Lastly, the Fed has only hinted at a dovish shift but December Fed meet could hold the key. The RBI may look to change the stance at a later date but has opted to stay hawkish.
Liquidity issues addressed
There was the big expectation that the RBI would focus extensively on liquidity considering the huge shortfall in the financial markets. The RBI has been pumping Rs.40,000 crore per month into the financial markets and has promised to keep the taps flowing. In addition, the banks have also agreed to keep the liquidity taps open so that the NBFC sector does not suffer in delivering the last mile. Towards that effect, the RBI has also continued with its SLR cut. Effective January 2019, the SLR will be cut in 6 tranches of 25 bps each from the current level of 19.5% to 18%. This will technically ease liquidity in the banking system but the big question is whether it will push more lending since banks are already holding excess SLR.
Going beyond the MCLR
One of the big announcements in the policy was the decision to benchmark all retail and MSME loans to an external benchmark like the T-Bill yields. Currently, loans are benchmarked to the MCLR and that is often not linked to the market reality. But there are practical problems. Firstly, how do you follow market benchmarks when your loans are not exactly market driven? Secondly, the spread over the benchmark is still subject to banker discretion. Lastly, these things have been tried in the past and found to be impractical. It is MCLR that works best in these cases! ©