RBI’s Monetary Policy Review: Structural Reforms At The Centre Stage

Reserve Bank of India (RBI) unveiled its 4th bi-monthly monetary policy statement by keeping its benchmark repo rates intact in sync with market expectations. While maintaining its neutral policy stance, RBI cuts statutory liquidity ratio (SLR) by 50 basis points to bring it down to 19.50 per cent from 14 October 2017. It must be able to soothe markets waiting for some growth impulse. Correspondingly, in classifying the government securities into ‘held to maturity’ category that does not need mark to market is also brought down from 20.25 per cent to 19.5 per cent by 31 March 2018. This will link government securities with market determined rates to remove internal rate adjustment at bank level. Reduction of SLR can enable banks to further soften lending rates and help quicker transmission.

With consumer price index (CPI) inflation and its dependencies showing signs of escalation and RBI is well committed to maintain inflation close to 4 per cent on durable basis. RBI projects CPI inflation to be in the range of 4.2-4.6 per cent in the second half of financial year (FY) 2018. Moreover, the monsoon shortfall of up to 5 per cent in some parts has led to lower estimated kharif production that may fuel food inflation. Except services sector, no other sector is able to reflect growth uptick. As a result, RBI projection of real gross value added (GVA) growth is brought down to 6.7 per cent for FY18 scaling it down from its earlier estimate of 7.3 per cent. While inflation, repo rates, market volatility are near term transient factors, more focus is on structural reforms that can form a firm footing to accelerate pace of economy on a durable basis.

Strengthening Structural Reforms

Thus, going beyond the short-term measures, RBI is keen to remove the deficiencies in determining marginal cost of funds based lending rate (MCLR) of banks for speedy transmission of monetary policy actions. An internal study group led by Dr Janak Raj has gone into MCLR structure and has suggested switch over to an external benchmark system to remove any arbitrariness in fixing MCLR at bank level. This will facilitate realistic linking of MCLR to market determined benchmark rates to weed out possibility of random loading of costs on borrowers. The improved system can lead to seamless quick transmission of interest rates linked to markets that may revive sagging demand for bank credit.

Another high-level taskforce led by Y M Deosthalee has also been set up to suggest architecture for introducing public credit registry (PCR) to improve information system on credit. The state-of-the-art information system on credit on real-time basis can improve decision support system in banks and non-banks. The internationally comparable PCR can also exert a moral pressure on borrowing community to maintain an impeccable transparent record to stay in business. As part of next initiative of strengthening the framework of central repository of information on large credit (CRILIC), RBI makes it mandatory for banks to insist for ‘legal entity identifier’ for borrowers of Rs 5 crore and above to enable banking system to monitor the aggregate borrowing by corporate groups. These seminal measures can prevent excessive and unsustainable lending and borrowings from banking system to eventually help improve the asset quality. In this context RBI has assured to work towards speedy resolution of existing stock of stressed corporate exposures by coordinating with banks and other stakeholders. The efforts should bring results in medium term.

Expanding Financial Intermediaries

Keeping in view the need to revive investment activity to stimulate growth, RBI has called for restarting stalled projects. The peer to peer (P2P) lending platform has been institutionalised as a non-bank entity to be regulated. Creation of such intermediary will eventually open up opportunities for lending and borrowing of small units of funds under the regulatory scanner of RBI. Entrepreneurs unable to access formal bank credit can now access funds through P2P and pursue their enterprise. The prudential norms have been spelt out where P2P NBFC entity has to obtain a certificate of registration. Once stabilised, this forum can be an effective means to fund micro and small entrepreneurs on a continuous basis to augment growth prospects.

Strategic Issues

While easing the working of cooperative banks, RBI addressed some of the concerns of senior citizens, differently abled persons and non-resident Indians (NRIs). Reforms in the areas of financial markets and payment and settlement systems have been mooted to make them more vibrant and user friendly. RBI succinctly flags its concerns on the impact of farm loan waiver on fiscal state. The need for adequate infusion of capital in public sector banks too has been highlighted to restore their lending appetite. It observed that while the impact of demonetisation may gradually phase out, it will be essential to make implementation of goods and service tax (GST) regime more compatible to continue to expand formal economy.

Based on the RBI survey, firms expect significant improvement in business sentiments in the third quarter. It will be further aided by structural reforms initiated in continuation of policies already set in place. The monetary policy statement reinforces series of tailored measures to augment sustainable growth in the medium to long term, more visible in the second half of FY18.

Therefore, RBI has combined its medium and long term vision to make banking system more market driven, robust and agile provided government is able to play its own supportive role. Using the set of structural reforms mooted by RBI, banks have to concentrate on speeding up debt resolution. Eventually, an ecosystem has to be built to ring fence asset quality to provide sustainable financial intermediation to spur growth.