Prolonged pause likely as RBI balances growth, inflation risks: SBI Ecowrap

With the RBI MPC unanimously deciding to keep the policy rate unchanged at 5.25%, while also continuing with the neutral stance, on Wednesday all eyes and ears naturally turned to the undertone and reading between the lines of the Governor statement even as ample indications of the MPC being in a wait-and-watch stance in a flux like situation was self-evident, according to SBI Ecowrap.

“We quantified the information in the policy text using Natural Language processing techniques and created a dovish/hawkish tone score using our custom-made dictionary. Out of the eight statements by the current governor, this statement is most cautious/hawkish in our opinion but does not mean a rate hike is imminent. The choice of words and the latent signal the latest statement carries reflects deep understanding of the evolving geo-economic situation in the world without hinting at any imminent rate hike with regulatory gaze hobbling between growth and inflationary concerns,” said Dr. Soumya Kanti Ghosh, Group Chief Economic Adviser, State Bank of India.

Average inflation is projected at 4.6% for FY27, with core inflation is projected at 4.4% for FY27. As on date, RBI expects FY27 real GDP growth at 6.9% with progressive upgrades in the second half of the current fiscal. Further, volatility in crude oil and other commodity prices along-with possible El Niño conditions impart considerable volatility to inflation. However, the near-term food supply prospects have been boosted by robust rabi crop providing some comfort. RBI has also indicated that it will be actively intervening for managing liquidity.

On the regulatory and development front, the regulatory measures have largely focused on banking sector. The RBI has proposed to rationalize two guidelines that affect the capital planning of banks. The first proposal is to remove the rider on deviation in incremental NPA by 25% for taking quarterly profits in calculation of CRAR. This proposal gives considerable flexibility to banks to internal plough back. The second proposal is to dispense away with the requirement of investment fluctuation reserves (IFR). The IFR was additional reserve under Tier 2 to cover the losses on non-HTM investment book. With banks already covering these losses under capital charge for market risk and other income recognition provisions, IFR was a duplication in some sense. The proposal irons out this and makes risk recognition more transparent and simpler. Also, basis some rough back of the envelop calculations, Indian Commercial Banks can see the IFR corpus of around 35-40,000 crore getting freed up through reversal (@2.5 of HFT and FVTPL-AFS portfolios of around Rs 14 lakh cr book, presuming a straight jacketed ~20% of Banks investment book of around 70 lakh cr). This corpus can be used optimally and judiciously by Banks between CET-1 and P&L account even when yields have moved substantially up during last quarter.

To strengthen the governance by way of optimal utilization of time, it is proposed that board level activity governed by RBI directions will be rationalized with more strategic policy making and risk governance. That should make boards more attuned to screen evolving landscape dotted with risks, a prerequisite in these tumultuous non-linear times. On the supervision side, the RBI has further consolidated 64 Master Directions in nine functional areas thus reducing the compliance cost for banks. On the payment system side, it is proposed to dispense with the requirement of due diligence of MSMEs while onboarding on TReDS platforms. This measure is expected to further increase trading volumes on platform and offer liquidity to the sector. Banks and regulators would however need to identify risks inherent proactively on this front.

Finally, on the market development side, participant base of the term money market is proposed to be expanded to include non-bank participants viz., AIFIs, NBFCs, HFCs with enhanced limits for specified PDs. Since banks are net lenders, the move is positive as it expands the demand for funds and deployment of intraday surplus funds. This move is largely expected to

have a sobering impact on yields going forward. Interestingly, as emphatically iterated by the Governor today, the rapid depreciation thrust upon the INR off late is not in sync with India’s macro fundamentals and a course correction was a much-needed recourse with currency now retreating towards its implied value, with a sledge hammer pounding from the Mint street paving the way. Similarly, for an emerging market, targeted fx intervention remains an absolute necessity.

Can we pitch the GIFT city as a credible alternative to global financial centers with less compliance and regulatory hurdles that dissuade the vicious loop and biases impacting downward outlook on rupee?

Overall, we expect a prolonged pause as the natural outcome under current uncertain global environment.