Editorials : Banking on credit

With inflation surging above the upper band of the RBI’s monetary framework, and expected to remain elevated in the coming quarters well, the Monetary Policy Committee (MPC) has chosen to maintain the status quo on rates along expected lines. But the tone of the policy statement was decidedly dovish with the MPC repeating its intention to maintain its accomodative stance till as long as necessary to revive growth. Even though the outlook for inflation remains highly uncertain, governor Shaktikanta Das repeatedly emphasised that there was scope for further rate cuts down the line. But when and by how much rates will be cut depends on how quickly inflation falls. The RBI expects retail inflation to average 6.5 per cent in the fourth quarter of the current financial, trending down thereafter to 3.2 per cent in the third quarter of the coming financial year, which could then open up space for monetary easing.

Higher inflation has restricted the policy space for the MPC, but not the RBI. The central bank has taken recourse to credit policy and other tools available to it to stimulate the economy. These measures signal its unequivocal intention to boost growth. The strategy broadly operates at two levels — first, hasten the transmission of interest rate cuts to the broader economy, and second, boost credit flow to select sectors. The first leg has been operationalised through tweaking the liquidity framework, and conducting Rs 1 trillion long-term repo operations. This will enable banks to fund at a lower rate, and also bring down the term premium at the short end of the yield curve. Short-term G-sec yields should now gravitate towards the benchmark rate. This strategy is a continuation of its existing programme — dubbed operation twist — where the RBI has sought to bring down long-term yields through open market operations. By opting for this route, as analysts have pointed out, the central bank has delivered easing without cutting the policy rate. With the risks of an NBFC contagion slowly abating, over time, these measures should also lead to a lowering of credit spreads, effectively lowering the cost of borrowing across the broader economy.

The second leg of the strategy aims to boost credit flow to select sectors. The RBI has provided relief to banks for incremental loans extended to auto, real estate and MSMSEs, by reducing the cost of lending by waiving off the requirement of cash reserve ratio. This outcome-based cost intervention, which seeks to direct credit to select sectors will presumably have high multiplier effects, and could stimulate a recovery in the broader economy. But the strategy of directing credit to select sectors is questionable. And though other measures to ease stress in the commercial real estate sector and of MSMEs have been welcomed, the central bank should be mindful of the risks of forebearance.
Courtesy - The Indian Express.

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