Calibration of monetary policy gets clarity in 2015

In 2015, the RBI was at the forefront, when it came to spearheading the country’s economy.

Along with issuing “in-principle” licences to various small banks and payment banks, the RBI was at the centre of several headline-grabbing events in 2015; be it Raghuram Rajan’s calculated jibes at the Finance Ministry, or the proposed changes in the RBI Act, resulting in an en-masse leave by RBI employees in November.

Monetary policy
Though the RBI cut interest rates by 125 bps in 2015, the monetary transmission is highly inadequate. The interest rate in the system is not declining, which is evident from the marginal decline in the 10-year yield, from 7.92 per cent a year ago, to around 7.75 per cent, at present.

“One has to appreciate the fact that even deposit rates have not gone down proportionately. The major factor standing in the way of monetary transmission is the poor health of the banking system, as reflected in the high level of stressed assets.

Also, the banks are not in a position to cut deposit rates beyond a point, since the interest rates of small savings are relatively higher. For better monetary transmission, the RBI will have to address this issue,” said V K Vijayakumar, Investment Strategist, Geojit BNP Paribas.

The new methodology proposed by the RBI for calculating the Base Lending Rate is the MCLR — Marginal Cost Lending Rate, which will come into effect from April 2016. This, along with the new payments banks and small banks that start operations next year, will lead to increased competition in the banking space.

“The inevitable consequence of this will be decline in the market share of PSU banks, and the increasing market share of private sector banks,” added Vijayakumar.

The government plans to change the Reserve Bank of India Act before the end of this fiscal year, so it can set up a new committee to direct India’s monetary policy, retiring Finance Secretary Rajiv Mehrishi said in August.

The committee would comprise appointees from the government, RBI, and independent members appointed by the government, but any changes have to be approved by the Parliament, which has blocked other government bills.

There were also talks about curbing the powers exercised by the RBI Governor.

Changes in the RBI Act
“I hope the proposed changes in the RBI Act will strengthen the independence of RBI rather than weakening it. I hope the monetary policy committee will enable this. If indeed, the responsibility of controlling inflation is assigned to the Governor, he should have the discretionary powers to determine the rate.

However, whenever he uses his discretionary power, he should explain the rationale to the public. In fact, that is the recommendation of the Financial Sector Legislative Reforms Commission (FSLRC),” said M Govind Rao, Member, Fourteenth Finance Commission.

Having said that one of the major highlights of 2015 has been the clarity in the calibration of the monetary policy.

“The austere policy aided by low oil prices has helped bring down the inflation rate. The shifting of the target to consumer price index is clearly appropriate, and provides realism to calibrating the policy. The reduction in the rate by 125 bps is accommodating, and further cuts will depend upon the government’s compression of fiscal deficits,” Rao added.