The RBI has continued to tighten the benchmark rate in its bid to contain inflation which has been on the rise. Substantial inflationary pressures exist on account of high crude prices, contingency of monsoons, high global food prices and demand-supply imbalance.

However, the policy expects inflation to moderate in the second half of the fiscal year and projects inflation at 6 per cent by year-end which seems a slightly optimistic figure. The tightening policy stance also acknowledges that there are downside risks to growth on this account.

The central bank has projected the baseline growth to be at 8 per cent for FY 12. The regulator has also stressed that fiscal policy has to be in tandem with monetary policy and has its limits on macro prudential management in case of a disconnect.

Concern over fiscal gap

The policy raises concern that achieving target fiscal deficit levels for 2012 will be a challenge due to subsidy burdens.

The adoption of the Deepak Mohanty committee recommendations are welcome as it imparts greater transparency and focus by having a single benchmark rate linked to the overnight call money rate.

The creation of a new instrument — Marginal Standing Facility (MSF) — for overnight borrowing will help contain volatility in the inter-bank market. Monetary policy tools will now be more sensitive to call money rate.

The regulator also raised the savings bank rate, indicating that the deregulation is a matter of time and that savings rate should be a function of economic conditions.

This will lead to a rise in banks' cost of funds, especially for banks with larger CASA deposits but will also be a fairer deal for the customers.

Banks' margins might be hit in the medium- to long-term as the savings rate becomes competitive and market-determined.

MFI rate cap

The RBI also made significant announcements accepting the Malegam committee recommendations and this will have significant impact on banks and MFIs.

Given the government thrust on financial inclusion, political connotations and the objective to provide timely and cheap credit to the disadvantaged population, a sharper look at what constitutes priority sector lending was required.

Banks lending to MFIs and NBFCs working as MFIs will constitute priority sector lending and loans to other NBFCs will be excluded.

Those loans which qualify should also adhere to qualification and pricing. The proposed interest rate cap of 26 per cent is still high, but the journey from exorbitant 48-50 per cent rates to 26 per cent has been fairly eventful and quick.

Financial inclusion

Financial inclusion will get a further boost from allocation limit of branches in tier 5 and 6 cities and leveraging the presence of urban cooperative banks (UCBs) in the rural areas and smaller towns.

Allowing foreign institutional investors to cancel and rebook a larger part of the portfolio hedge will allow greater leeway to FIIs to manage exchange rate risks of the portfolio better.

Significant announcements on the developments on new banking licences, foreign banks and bank holding company were expected, but these might take a while now.

(The author is Partner and National Leader, Global Financial Services, Ernst & Young.)

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