A monetary policy beyond rates: Why RBI's latest moves matter more

The MPC in June decided to keep the policy repo rate unchanged at 5.25 per cent. However, the macroeconomic assessment in the June cycle underwent some revisions in consonance with evolving uncertainties, with risks to both inflation and growth having increased. Central banks in advanced economies are likely to pivot towards monetary policy tightening. In fact, the US dollar index has appreciated amid shifting rate expectations in the US.

 

On the domestic front, the assessment remains optimistic. The high-frequency indicators indicate that domestic economic activity has remained largely steady since February. The GDP growth numbers for Q4FY26 at 7.8 per cent bear testimony to this. Both consumption and investment have not lost momentum even as it is widely anticipated that elevated energy and other commodity prices, coupled with continued supply disruptions, could impinge on economic activity.

 

The concerns on monsoon and El Nino are visible. The outlook also remains clouded by the sub-normal south-west monsoon forecast and El Nino risks. Real GDP growth for FY27 is now projected at 6.6 per cent, with a progressive scale-up in growth estimates in Q2FY27.

 

Measures to tide over the impact of the war in West Asia, such as support to MSMEs and export sectors, efforts to ramp up domestic gas and crude supplies, encouraging the use of domestically produced alternatives to imported inputs, and diversification of critical imports, are expected to help in FY27.

 

Given the supply shock, CPI inflation for FY27 is projected at 5.1 per cent, with inflation hitting a peak of 5.9 per cent in Q3. Core inflation is projected at 4.7 per cent for FY27.

 

Most importantly, the slew of reforms announced in today's meeting to support the rupee augurs well for the economy and markets while keeping the growth momentum sacrosanct.

 

Firstly, with the RBI bearing the full hedging cost and also the SLR and CRR costs till September 30, banks can now offer more attractive FCNR(B) rates to NRIs without taking unhedged currency risk. The current FCNR(B) rate is about 3.35 per cent (three years). Presently, the cost of hedging, or forward premium, is about 3.5 per cent. The current card rate for a three-year deposit is 6.5 per cent. Banks can thus offer attractive FCNR(B) pricing in the range of 5.5 per cent and upwards (US Treasury rates are about 4 per cent for equivalent duration). We believe FCNR(B) deposits could easily attract upwards of the $34 billion that was mobilised in 2013.

 

A successful deposit mobilisation should largely alleviate constraints faced on the domestic deposit mobilisation front and should have a sobering effect on loan pricing and other market-based yields across CPs, CDs and G-secs, helping in true transmission. Interestingly, credit growth is likely to surprise on the upside, with nominal GDP growth of at least 12-13 per cent in FY27, and a stronger deposit inflow will ensure adequate funding of credit opportunities at reasonable rates.

 

Secondly, concessional forex swaps to incentivise ECB issuances by PSUs should accelerate such offerings by PSUs in overseas markets, helping them access funds at competitive net pricing and lift total ECB/FCCB flows that fell by about 30 per cent in FY26 to $42.9 billion from the FY25 level ($61.2 billion). Major PSUs raised ECBs amounting to $4.9 billion in FY26, which is about 11 per cent of the total in FY26, mostly in the maturity period of 5-7 years.

 

Thirdly, reforms in the FAR category and General Debt category are likely to pull in much better flows, in sync with the GoI's measures facilitating better post-tax returns for FPIs. Currently, the FPI position in FAR is Rs 3.24 lakh crore (limit utilisation of 6.8 per cent), with an average tenure preference of 11 years. The inclusion of the new tenures along with the full tax exemption implies the post-tax return on G-secs is now higher, which would lead to more inflows. The limit of 30 per cent on short maturity has also been removed and we expect this maturity segment to see maximum demand, given expectations of a rise in rates. The available headroom in both the general and general long-term routes is Rs 4.06 lakh crore, which is indicative of the potential inflows.

 

It is worth noting that the policy statement has again emphasised in no uncertain terms that sometimes the rupee's movement is not in sync with fundamentals. This puts to rest the recent unnecessary catcalls that the rupee should be allowed to move even towards 100. Such needless assertions create unnecessary bouts of speculation and allow incremental market positioning that takes fundamentally undesired bets against the rupee. 

(The author is Member, PMEAC; Member, 16th Finance Commission; and Group Chief Economic Advisor, State Bank of India. Views are personal.)