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Informist, Monday, Aug 26, 2024

MUMBAI - The Reserve Bank of India has the scope to cut rates while keeping credit conditions stable, ICICI Securities Primary Dealership said in a research report today. The central bank should emphasise metrics of financial conditions to help markets reduce an excessive focus on the policy rate as monetary policy, the report said.

"RBI may be able to manage the twin objectives of easing monetary conditions even while keeping credit conditions on an even keel, should the opportunity arise for modest policy easing," the report said. The central bank's Monetary Policy Committee decides on the policy repo rate, which is currently at 6.50% since February 2023, every two months.

Financial conditions in the money market and the credit market appear to be in divergence. According to the primary dealer's proprietary financial conditions index, financial conditions were "easy" as of July, and were last "tight" only before the COVID-19 pandemic. The central bank has successfully eased money market conditions since January, while at the same time tightening credit conditions over the past year, the report said.

Trend over the past three years has shown that when the RBI started hiking rates, credit conditions in the market started to ease. Broadly, the two indicators have fluctuated around the neutral zone, the report said. At present the money market conditions have become easy while the credit index shows tighter conditions. "It is unlikely (that) RBI will have any big worry with this pattern, in our view," the report said. 

The report said that the key driver to tight credit conditions was lower growth in money supply, and not a slowdown in credit growth. Money supply increased by 10.2% on year in July, which was lower compared with the pre-pandemic average of 13.3% on year. This should not be construed as the RBI clamping down on credit, but rather a natural evolution of a return to its long-period average following the pandemic period of excessive growth in money supply, the report said.

The tightening in credit conditions has been more through regulatory measures rather than those undertaken through monetary policy, the report said. In November, the central bank increased the risk weight on exposure to consumer credit, including personal loans, of commercial banks and non-banking financial institutions to 125% from 100% earlier.

"...the slightly diverging fortunes of Money market and Credit indicators should also provide some comfort to RBI as it tries to calibrate monetary policy while curbing some sectoral over-exuberance in bank lending," the report said.

Even as the stance of the Monetary Policy Committee has remained unchanged at 'withdrawal of accomodation' since June 2022, the RBI has eased the liquidity conditions in the economy over the last few months. There was ample surplus in core liquidity in the banking system after the RBI's record dividend to the government, the report said. For 2023-24 (Apr-Mar), the central bank transferred a 2.11-trln-rupee surplus to the government in May, over double the budgeted amount.

The shadow interest rate, which takes into account a central bank's balance sheet and liquidity management with its monetary policy, rose from 6.09% in Feb 2023 to 7.31% in Jan 2024 due to tightening of liquidity in the economy. However, from January, the rate fell to 6.12% by July, according to the report.

"...with RBI having shown the ability to manipulate monetary conditions from just below neutral to above and vice versa, the urgency to act on rates is not there," the report said. ICICI Securities Primary Dealership expects the MPC to cut the repo rate only starting February. "To be sure, this kind of flexibility with liquidity levers clouds the market’s understanding of the MPC reaction function and lowers the salience of rate actions at the margin."  End

Reported by Srijita Bose

Edited by Akul Nishant Akhoury

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