RBI's right call

Policy rate pause and debt recast window make sense

The Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI), which will soon complete four years of operation under the new framework, on Thursday rightly decided to keep the policy rates unchanged. Although it is correct that economic recovery is flagging with a continued surge in Covid-19 cases and re-impositions of lockdown in various parts of the country, the outlook for inflation remains fairly uncertain. The rate-setting committee in its resolution, for instance, has noted that reduction in price pressure in key vegetables has been delayed and depends on supply normalisation. Apart from potential pressure from protein-based food items, the outlook for non-food categories remains hazy. Higher taxes on petroleum products have pushed up pump prices and will result in cost-push pressure for the broader economy. Inflation based on the consumer price index was above 6 per cent in June, while core inflation was at 5.4 per cent. The persistent supply-chain disruptions would have implications for price rise. The central bank expects inflation to remain elevated in the second quarter of the current financial year and moderate in the second half of the year, partly because of a favourable base.

Besides the uncertainty on the inflation front, which needs careful monitoring, it is logical for the central bank to wait and watch how its previous interventions are working in the economy. In addition to cutting interest rates, the RBI has infused significant liquidity into the system, which has improved transmission in both the bond market and banks’ lending rates. Another rate cut at this stage would not have had a significant impact. Liquidity can continue to increase because of the RBI’s intervention in the currency market. The decline in imports is likely to result in a significant balance of payments surplus in the foreseeable future. India’s foreign exchange reserves have increased by $56.8 billion in the current financial year so far. A surge in domestic liquidity could pose risks to both price and financial stability. Moreover, since the economic difficulties are unlikely to abate soon, it is important for the central bank to preserve some policy firepower.

On the regulatory side, the RBI has decided to provide a window under the Prudential Framework, which would enable lenders to implement a resolution plan for eligible borrowers, subject to certain conditions. The lenders would be able to classify such exposure as standard assets. The RBI has also decided to constitute an expert committee under veteran banker K V Kamath to suggest financial parameters and sectoral benchmarks for resolution plans. This is a step in the right direction. A large number of borrowers with a good repayment track record have been hit by the pandemic and need relief. While the regulator seems to be taking precautions to avoid past mistakes, it will be vital to make sure that the window is not used to kick the can down the road. Also, this is a good way of dealing with the situation compared to another blanket moratorium extension. 

However, at a broader level, aside from both inflation and growth outcomes, how quickly the corporate balance sheet is repaired will depend on containing the pandemic. A continued surge will limit the efficacy of policy interventions and increase risks to financial stability.