Rate cut, regulatory move to be in focus under Guv Malhotra-led RBI

The new leadership at the Reserve Bank of India (RBI) under Governor Sanjay Malhotra, along with an almost revamped Monetary Policy Committee (MPC), has set the stage for critical decisions in 2025 regarding policy and regulatory changes amid weak gross domestic product (GDP) growth and a depreciating rupee.

 

Three new external members of the MPC were inducted in October, with two of them already voting for a rate cut in the December policy. There would be more changes in the rate-setting panel, as Deputy Governor Michael Patra, who is in charge of monetary policy, is set to complete his term in mid-January. The government has started the process to appoint his successor. Also, the terms of two other Deputy Governors — T Rabi Sankar and M Rajeshwar Rao — will end, respectively in May and October next year.

 

The MPC’s scheduled review in February will throw some light on the interest rate trajectory. While rates are certain to come down, particularly after the dismal September quarter GDP growth numbers announced last month, questions remain about the timing and the extent of the downward cycle. Economists, who were expecting a shallow rate cycle of 50 basis points (bps) earlier, now estimate a 100-bp cut after the below par growth numbers.

 

What could jeopardise the prospects of an early rate cut is the recent downward pressure on the rupee’s exchange rate. The RBI’s exchange rate policy is another area under close scrutiny. Over the past two years, the RBI has adopted a strategy of gradual rupee depreciation. In 2022, the rupee weakened by 10 per cent against the dollar in the aftermath of Russia's invasion of Ukraine. Since then, the central bank kept the exchange rate within a tight range, with a modest 0.6 per cent depreciation in 2023. It took the rupee 475 days to fall from 83 per dollar to 84 against the greenback.

 

However, in about two months after touching 84 against $, the rupee went past the psychologically crucial level of 85 per $ and went on to hit 85.82 on Friday, before the central bank intervention pulled it back to a new closing low of 85.52. Coinciding with Malhotra taking charge, the Indian unit has fallen 1.3 per cent against the dollar in December, making it one of the worst-performing Asian currencies for the month. In 2024 so far, the currency has weakened 2.7 per cent against the greenback.

 

There are at least four important regulations awaiting the commercial banks that could impact their growth and profitability. The first among them is the implementation of the Expected Credit Loss (ECL) framework for loan provisioning. Unlike the current regime, which requires provisioning only after a loss is incurred, the ECL framework mandates banks to make provision for loans in anticipation of the assets becoming stressed.

 

A discussion paper on this issue was published last year, followed by the formation of an external working group. The RBI had said the draft norms on ECL norms are likely to be published soon.

 

The other is the final guidelines on infrastructure finance. Draft guidelines issued earlier this year proposed increasing provisioning on standard assets during the construction phase to 5 per cent from 0.4 per cent now. If implemented, this could raise provisioning requirements, particularly for lenders with large infrastructure loan portfolios.

 

Draft norms on liquidity coverage ratio has made some banks worried as it mandated additional run-off factors for calculating Liquidity Coverage Ratio (LCR). According to estimates by rating agency ICRA, the proposed changes will reduce the system-wide reported LCR by 14-17 per cent, from 130 per cent reported during Q4 FY24 to 113-116 per cent because of higher run-off factors for certain deposits and haircuts on the high-quality liquid assets.

 

Earlier this year, a draft norm for a disclosure framework on climate-related financial risks was also released. The final norms on this framework is also expected in 2025.

 

In the banking sector, developments regarding universal and payments banks licences to two entities will be keenly watched. While Bhubaneswar-based microfinance institution Annapurna Finance applied for a universal bank licence in January 2023, AU Small Finance Bank followed suit earlier this year after the RBI announced guidelines for the voluntary conversion of small finance banks (SFBs) into universal banks. Similarly, Fino Payments Bank’s application for a SFB licence, submitted in December 2023, remains under review. The RBI has not issued a universal bank licence in the past decade. 

RBI watch list  

-  Key decisions on interest rate cuts amid slow Q2 GDP growth 

-  Impact of rupee’s depreciation on inflation and reserves

-  New loan provisioning rules affecting banks' profitability; increased provisioning for infra loans

-  Developments in new bank licences and regulatory changes

-  Deputy Governors Michael Patra, T Rabi Sankar, M Rajeshwar Rao to complete their term next year