👍👍👍👍👍MPC does a tightrope walk

https://www.thehindubusinessline.com/opinion/mpc-does-a-tightrope-walk/article67183713.ece

Another pause by the MPC is no sign that the peak policy rate is here

BY HIMADRI BHATTACHARYA

The stance of the policy was also kept unaltered, albeit with one member dissenting.

The obvious upshot of the fresh projections is that achievement of the target of 4 per cent for the headline CPI will likely be a long and arduous affair even under the best of circumstances, i.e., when the risks are evenly balanced. The MPC is surely mindful of the fact that even if the actual CPI remains in the 5-6 per cent range for a long period, the credibility of its commitment to achieving the target of 4 per cent will suffer. Nevertheless, the MPC can derive some comfort from the fact that the core inflation (inflation sans food and fuel) has softened by more than 100 basis points from its recent peak in January 2023. But crude price will continue to be vulnerable to any renewed geopolitical tension.

Incremental CRR

This measure would impound from the banking system an estimated ₹75,000 crore or about 40 per cent of the current daily absorption of liquidity under LAF. Use of CRR for inter-temporal liquidity adjustment is likely to send a wrong message, indicating some weakness of the LAF tools and OMO that have long been used by the RBI. Is it the case, therefore, that a CRR enhancement at the margin has been announced to buffet the overall hawkish tone of the policy? Only time will tell.

Regulatory policies

The extant regulatory framework for financial benchmarks related to forex, interest rates, money markets and government securities that was issued in June 2019 applies only to the so-called ‘significant’ benchmarks. By implication, administration of other financial benchmarks, and there are quite a few important ones in this category like indices of government securities, forward forex market rates, etc., are currently beyond the regulatory purview. This creates anomalies and regulatory arbitrage.

Administration of financial benchmarks is a critical function and it is necessary that all the agencies pursuing this business are subjected to a uniform set of regulations so that there is a level-playing field, on the one hand, and best-of-the-class governance standards entailing, among others, complete absence of any conflict of interest, on the other.

One expects that these issues will be properly addressed in the revised directives to be issued by RBI. One also hopes that all the major financial market regulators — RBI, SEBI, IRDA and PFRDA — will work jointly to pave the way for the use of uniform valuation benchmarks in respect of corporate bonds by all the regulated entities.

The steps announced for enforcing greater transparency in interest rate reset of EMIs in loans bearing floating interest rates, though welcome, stop short of addressing a fundamental design flaw of most such loans: mismatch between the tenor of reset (usually three months) and the tenor of the interest rate (mostly overnight policy repo rate). Apart from giving rise to wrong incentives for the lenders and their borrowers, the interest rate risk associated with such a design becomes a bit complex, the hedging of which poses few additional challenges.

Has the current tightening cycle already reached its peak at 6.5 per cent? The most optimistic opinion in this regard tells us that the MPC will begin to reduce the policy rate towards the end of June 2024 — more or less at the same time when the Federal Reserve is also expected to do so. 

keeps alive the possibility of another rate hike by 25 basis points later in FY 2023-24.

The MPC will likely be ever more watchful of the second-round effects of high food prices and the consequent challenges to the anchoring of inflation expectations.