DNA Edit: Twin Worries For MPC - IL&FS and oil-hike linked inflation to dominate meeting

The continuing upheaval in the equity markets — weakening currency, sell-off in the bond markets, concerns in the credit markets, and the cloud of uncertainty over NBFCs — has created a situation, which the monetary policy committee (MPC) has to address in its next meeting on October 4.

All eyes will be on MPC as this is possibly the most challenging meeting it will have since its formation two years back. Till now, the MPC has focused its discussion on inflation and its impact on the larger economy. Now, oil-hike linked inflation risk and it ensuing impact on the exchange rate are big worries as the central bank cannot allow inflation to get out of hand and heat up the economy just when growth is reviving.

The fourth bi-monthly monetary policy of the financial year will be unveiled on October 5, 2018. Oil is hitting $80 a barrel; there is an unrelenting trade war between United States and China that has to be tackled. The rupee has slid 12 per cent this calendar year to cross Rs 73 to the dollar during trade last week.

While inflation is the preoccupation of the six wise men of Reserve Bank of India’s MPC, the equity and credit markets and domestic and foreign investors will be looking for cues on the risk ahead. Politicians are already jittery about markets turmoil affecting the assembly polls and general elections in 2019.

The contagion impact of the failure of one of the biggest NBFCs, IL&FS with a liability of Rs 91,000 crores on its books, will be part of the discussion. MPC will try to tackle the situation by ensuring that the credit markets are sound.

RBI may also toy with the idea of pruning the exposure limits to various sectors. There are about 80,000 NBFCs registered with the Central bank. However, the large ones are about 25 to 30. They have been growing at 25 per cent but this will come down sharply as banks have already clamped down on credit to the sector.

Banks have deposited Rs 1.2 lakh crore back to the RBI’s reverse repo window from Rs 4600 crore in just three days last week shows that the banks are clamping down on credit in the market. Liquidity and governance issues for NBFCs are not going away any time soon unless RBI takes some measures to closely audit their books.

IL&FS, a AAA rated NBFC until a few months back, got downgraded from AA-plus to D in just nine days. It will certainly pose a challenging problem for the MPC. Earlier, the MPC was focussing on pulling out the banking sector from the doldrums with lenders struggling with a Rs 12 lakh crore non-performing assets on its books.

The only comfort that the bond markets are having now is the government commitment to keep the fiscal deficit at 3.2 per cent level. Until RBI tightens the lending and fund-raising mechanism of the NBFCs, the air of uncertainty will only thicken in the markets.