Credit policy supplements Budget growth boost: Business line online 7th February 2025

 

A perspective shift in managing growth-inflation mix, as well as bank regulation stand out in new RBI Governor’s statement

Given the virtual new look to the MPC’s composition, the Governor’s statement was bound to invite comparison with earlier ones. Quite apart from the decision to cut rates, the impression is that there has been a shift in policy perspective.

The first difference lies in acknowledging the achievements of the flexible inflation targeting framework, introduced in 2016. The fact that inflation has largely been within the band has been a vindication of its effectiveness. Further, the statement does convey the message that unlike the past when there was a focus on inflation being close to the target of 4 per cent on durable basis, a flexible band could be the driving factor to balance growth-inflation dynamics. Therefore, a band of 4-6 per cent would be more important than the 4 per cent number.

The second point made upfront was on some of the new regulations that are in the offing. There was assurance given that the central bank would be consulting with stakeholders and the implementation would be gradual, to enable the system to absorb these changes. This will bring relief to banks. Interestingly, there was mention of a trade-off between efficiency and cost when regulation is imposed.

The cut in repo rate was almost a given and opens the door for more rate cuts during the year. It can be said that as far as borrowers and lenders are concerned the peak interest rate regime has ended. The decision at the micro bank level will depend on other considerations, including liquidity.

Inflation outlook

The forecast of inflation at 4.2 per cent for next year could have an upside. This is so because two sets of factors need to be considered. The first is that even a normal monsoon always has been associated with periods of sharp increases in vegetable prices, particularly in the September-December period. This problem will remain until such time that the composition of the CPI is changed with the weights for products like tomatoes, potatoes and onions reflecting their share in consumption basket.

The second is the pressure of imported inflation. As the central bank’s position on the rupee is that the currency will be driven by market forces with intervention only in the event of excess volatility, there is reason to believe that the rupee can be pressurised depending on global factors, which are fluid as of date. Therefore, the threat of imported inflation does exist. The question is whether the government will raise prices of fuel products if the imported cost of crude oil increases sharply.

Further, core inflation would tend to be higher than that in FY25 as companies have been increasing prices of their products due to both demand (for services) and cost pressures (manufactured goods). In fact, historically, post 2012, core inflation has averaged 5-6 per cent and the low numbers witnessed in FY25 have been due to fortuitous conditions.

Growth forecast

The growth forecast made by the RBI at 6.7 per cent for the year looks reasonable; there can be an upside here, too. The push given by the government through the Budget along with the base effect should in the normal course lead to higher consumption and investment. The impediments of election uncertainty and high inflation which affected private investment, government spending and consumption in FY25 would not be potent factors in FY26. This number looks more optimistic, however, than what was projected in the Economic Survey which has placed growth in the range of 6.3-6.8 per cent.

Based on its assessment of the banking sector, the RBI appears to be fairly satisfied with financial stability. While no specific measures on liquidity were announced, it can be assumed that the central banks would continue with a combination of measures of OMO, VRR and dollar swaps to ensure that liquidity will be normalised. But interestingly, the Governor did point out to an anomaly where some banks have been parking funds with the RBI rather than lending in the call market. This was above ₹1 lakh crore on February 6. There is a clear nudge to banks to change this practice. This would help improve liquidity in the system.

The credit policy can be seen as an effective supplement to the Budget, where the government had focused on growth as the primary objective.