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The bi-monthly monetary policy is well crafted, grounded in realism and forward looking. The decision to cut repo rate is a balanced and pragmatic assessment of the evolving economic scenario. With headline inflation consistently undershooting the RBI’s inflation mandate, and inflation expectations materially down, a rate cut was the most desired outcome. The glide path of the CPI inflation has also been revised downwards and the policy stance has been shifted to neutral. This indicates that the rate cut cycle may just not be over yet.

The policy guidance is also guided by the fact that the global growth outlook has become more uncertain. Among key advanced nations, economic activity in the US lost some steam while in the Euro area, economic activity has lost momentum on weak industrial activity. Commodity prices, including base metal prices, are showing mixed trends. The internal growth signals are also indicating minor moderation in services. Thus, policy accommodation at this juncture was warranted to balance both internal and external growth sources. The fiscal measures provided in the interim budget have bolstered the growth outlook for FY20 at 7.4%. The rate cut of 25 basis points will support the overall growth trajectory, both through investments and private consumption.

This policy should perhaps be appreciated more for its development and regulatory proposals, since such steps could trigger a paradigm shift in the financial markets in terms of new understanding and thinking among market participants.

To start with, on the banks’ asset side, the relaxation of the external commercial borrowing (ECB) framework for resolution applicants, under the Insolvency and Bankruptcy Code (IBC), is a welcome move. The relaxation of end-use guidelines in this regard will hopefully speed up the resolution process, going forward, particularly in the final stages. The enhancement of limit for collateral-free agriculture loans is positive, given the general policy thrust to support agriculture. This decision is in conjunction with income support and will facilitate credit flow to small and marginal farmers.

On the liability front, the proposal to revise the fund limit for bulk deposits to 2 crore is likely to give better operational flexibility to banks for mobilizing retail deposits. This could be done by increasing the retail term deposit base and customers getting the benefit of better pricing. The proposal for setting up an umbrella organization for UCBs (urban cooperative banks) is also a good proposal to foster financial stability and better coordination.

The payment systems have emerged as important component of Digital India. The RBI has, therefore, drawn attention toward regulation of payment gateways and payment aggregators, which will help in orderly development of this segment.

Financial stability related to NBFCs has also received a specific mention. The decision to remove differentiation between similar rated NBFC and an ordinary corporate in terms of risk weight will free resources for banks in general, facilitate credit flow and prevent the risk of contagion to healthy NBFCs. However, this also depends on the rating distribution of the bank’s NBFC exposure. The harmonization of NBFC classification by replacing ‘entity-based’ regulation to ‘activity-based’ regulation will better align the respective entity with risk associated with its activity. Thus, NBFCs engaged in credit intermediation will be treated as a single entity, going forward.

Financial market development has been an ongoing process in this fiscal year. The policy endeavour for the development of onshore forex derivatives and allowing non-residents to access this market has reached logical conclusion. Furthermore, the RBI will rationalize the interest rate derivative markets by reviewing IRS/FRA guidelines, which have become outdated. The removal of exposure cap of 20% for single corporate for FPI (foreign portfolio investment ) will ensure more liquid corporate bond market.

One announcement which is of vital importance is the proposal to constitute a task force on offshore rupee markets. It has been known for some time that offshore rupee markets such as the NDFs (Non-deliverable forward) have grown in size. Although these markets have very little influence on domestic onshore price discovery of rupee, at times of stress, offshore markets dominate price discovery completely threatening financial stability. Such a feedback mechanism beyond the control of the central banks calls for better understanding of this market.

The outcome of this task force will be of vital importance for the stability of the external sector.

In conclusion, the policy needs much appreciation for its clarity and content. Given the economic outlook and global headwinds the choices made look appropriate and will be clearly conducive to growth and stability going forward.

Rajnish Kumar is chairman, State Bank of India.

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