External benchmarks to further boost monetary transmission: RBI report

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The transmission of the monetary policy to banks’ lending and deposit rates has notably improved since October 2019, facilitated by introduction of the external benchmark linked lending rate (EBLR) system, the Reserve Bank of India (RBI) said in a report published as part of its bulletin for April 2022. The trend in transmission is likely to improve further as the proportion of EBLR-linked loans increases, the central bank said.

The earlier internal benchmark-based lending rate regimes suffered from a multitude of issues, such as arbitrariness in calculation of the base rate/marginal cost of funds-based lending rate (MCLR) and spreads and long reset clauses, which inhibited efficient monetary transmission. The framework for pricing of loans under an external benchmark system improved the extent and pace of adjustment in lending and deposit rates in response to changes in the policy repo rate, RBI executives said in the report.

The EBLR system has also accelerated the pass-through to MCLR-linked loans, as changes in the benchmark rates lead banks to proactively adjust their deposit rates to protect their NIMs (net interest margins), thereby improving transmission to overall lending and deposit rates,” the report said. Thus, the impact of the introduction of external benchmark-based pricing of loans on monetary transmission has been felt across various sectors, encompassing even those sectors that are not directly linked to external benchmark-based loan pricing.

The economic recovery triggered by the receding of the third wave of the pandemic may be at risk from the hostilities between Russia and Ukraine, the RBI has warned. Stating that the disruption is increasingly evident in inflation prints, tightening financial conditions and a terms of trade shock accompanied by portfolio outflows, the central bank called for greater private investment to ensure growth is sustainable.

In its latest State of the Economy report, also published as part of the bulletin, RBI executives said the near-term global outlook appears grim, caught up amid geopolitical risks materialising rapidly, strained supply chains and the quickening pace of monetary policy normalisation. Emerging market economies are bracing to contend with shifts in risk sentiments and tightening of global financial conditions. All of these could produce real economy consequences which may thwart incipient recoveries.

The Indian economy is not immune to these negative externalities. The surge in commodity prices is already posing inflation risks, especially through the conduit of surging imports,” the report said. Rapidly widening trade and current account deficits, coupled with portfolio capital outflows, could weigh on external sustainability, the RBI said, although the strength of underlying fundamentals and the stock of international reserves provide buffers.