MPC's optimistic growth outlook augurs well for credit demand

The MPC's optimistic growth outlook for H2 FY2024 augurs well for the credit demand for the banking sector as well as the lenders, said Karthik Srinivasan of Icra

In its February 2023 review, the Monetary Policy Committee (MPC) of Reserve Bank of India (RBI) has raised the policy rates for the sixth consecutive time since May 2022. With the recent hike of 25 basis points (bps), and a cumulative hike of 250 bps, the repo rate now stands at 6.50 per cent as compared to 4 per cent at the beginning of the fiscal. The divergence within the views of the members of the MPC increased, with two members voting for a pause as compared to one in the previous policy meeting in December 2022.

We had expected a close call given that inflation has been on a declining trajectory and that the impact of previous rate hikes could be gauged before undertaking additional rate tightening. While the rate hike is in line with some of the market participants, it was widely expected that a hike would be accompanied with a change in policy stance to 'neutral' from 'withdrawal of accommodation', thereby signaling an end to the rate hike cycle. However, the MPC has maintained its policy stance, thereby indicating that the option for further rate hikes remains open, if inflation exceeds the MPC's projections.

We expect the MPC to remain vigilant and data dependent in FY24. With a rate hike and no change in stance, the bond yields on 10-year government security increased marginally by 5 basis points (bps) after the policy announcements.

The MPC's optimistic growth outlook for H2 FY2024 augurs well for the credit demand for the banking sector as well as the lenders. Hence, ensuring sufficient liquidity and deposits at reasonable cost becomes imperative for the banking sector to support this growth. The RBI has maintained that the systemic liquidity remains sufficient; and although there could be some reduction in these surpluses in coming months, it will ensure sufficient liquidity for productive sectors of the economy by various money market operations.

The RBI also highlighted the commitment to fiscal consolidation in the recently announced Union Budget for FY24. As a step to further enhance the facilitation of large government borrowings in a transparent manner, it proposed the introduction of Securities Lending and Borrowing (SLB) in Government securities. The ability of the short-seller to borrow the short-sold security at competitive borrowing cost is important for efficient price discovery of sovereign bonds. In the absence of adequate availability of short-sold security resulting in a short-squeeze, the borrowing cost of the short-seller may increase, thereby discouraging them.

The RBI also placed special emphasis on small borrowers as well as micro small and medium enterprises (MSME) by proposing regulatory changes by increasing transparency around the penal charges for overdue borrowers as well as enhancing the credit flow to MSME borrowers. Currently, the lenders recover penal interest as well as penal charges from overdue borrowers and hence the RBI has proposed the replacement of “penal interest” with reasonable “penal charges”. While we await the draft guidelines, the measure will have some impact on the revenues and profitability of the lenders having a high share of borrowers displaying higher “bounce rates” though more transparent and beneficial for the borrowers.

Further, wider participation by more entities on receivable discounting platforms can keep the pricing under check as the volume on these platforms increases. The flexibility to allow re-discounting by existing holders of such discounted receivables will aid liquidity of participants. Insurance coverage for the discounted receivables can also enhance the volumes and further reduce the pricing of such insured receivables; however, the appetite of insurance companies to issue such coverage remains to be seen.

Lastly, we will await the guidelines on Climate Risk and Sustainable Finance for the lenders. This is still an evolving area for all the stakeholders and proposals to issue guidelines on various aspects, especially the disclosure framework on climate related risk, scenario analysis and stress testing may bring uniformity in disclosures by lenders. This will also enable relative benchmarking across various lenders, going forward.

Karthik Srinivasan, senior vice-president and group head - financial sector ratings, ICRA Ltd. Views are his own.