Home / Opinion / Columns /  Opinion | MPC’s steps will help in reducing cost of capital

The monetary policy committee (MPC) has unveiled a policy that demonstrates an ability to think outside the box. The MPC had a lower degree of freedom to ease rates given the high Consumer Price Index (CPI) print and high trajectory for the first half of next year. The policy emphasized that the inflation trajectory remains “uncertain" and that the committee will remain vigilant about risks of price pressures becoming generalized. Growth forecasts have been cut and CPI forecasts raised. These trajectories are now much more in line with actual outcomes.

The major policy shifts emanate from the ‘Statement on Development and Regulatory Policies’ section. First, provisions of one- and three-year long-term repo operations of 1 trillion at the policy rate will lower bond yields. Corporate bonds in this tenor should also benefit and we should see spread compression for highly rated non-banking financial companies as well.

Second, there have been substantial changes to the interbank liquidity framework. The fixed rate lending operations (overnight repo and 14-day repos, totalling 1% of net demand and time liabilities) are gone and the system will now move away from an overnight system towards a longer-term horizon. This has many implications. The banking system will have to be more careful about liquidity management. More importantly, some form of stealth easing was happening anyway for a few weeks as the weighted average call rate was below the repo rate. The variability in overnight rates could rise, that is, in surplus liquidity conditions we could have overnight drifting toward the reverse repo rate and in tight liquidity conditions overnight could drift towards marginal standing facility rate (to be sure, the Reserve Bank of India has said it will conduct “fine-tuning operations" that could take care of unanticipated liquidity changes during the reserve maintenance period).

Third, the leeway provided for cash reserve ratio exemption on incremental retail loans should bring down pricing and channelize credit toward these sectors.

Fourth, some regulatory forbearance has been introduced for micro, small and medium enterprises and commercial real estate. For both sectors, the restructuring period has been extended before the accounts become non-performing assets. This will also incrementally ease credit flow to these sectors. In related developments, medium enterprises have also been included under the ambit of external benchmark-linked loans. This step basically moves a greater proportion of loans in the system to floating rates, thereby ensuring better transmission in the real economy.

All these will improve transmission into bond markets and lead to lower lending rates. More importantly, targeted intervention in stressed sectors will reinforce the government’s initiatives to boost growth. Additionally, for markets, proposals regarding the Rupee Interest Rate Derivatives market are likely to lead to greater participation of non-resident entities in onshore markets.

On the policy front, we expect a pause on the repo rate given high inflation trajectory but since the stance remains “accommodative" further cut(s) later during the year cannot be ruled out.

B. Prasanna is group head-global markets, sales, trading and research, ICICI Bank.

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