The RBI, like any other central bank, therefore finds itself in a bit of a challenging position now.
By Indranil Pan
On a headline basis, the policy has been on expected lines – not merely with respect to the repo and reverse repo rates but also the enablers that the RBI has consistently tried to build as a response to COVID-19 – that of keeping liquidity adequate, managing the government security yields and push credit to segments that are starved of funds. However, the RBI has attempted to sensitize the market about its role of anchoring inflation expectations at 4% and in the process reestablishes the element of credibility of market participants in the central bank.
The RBI, like any other central bank, therefore finds itself in a bit of a challenging position now. And the tightrope walk on the policy front is evident too. On one side, even as it has retained its growth projection at 9.5%, the commentary on growth is better than the June policy. It says that the outlook for aggregate demand is improving but the underlying conditions remain weak. Looking ahead, it expects rural demand to be resilient while urban demand will pick up with the accelerated pace of vaccination. Government expenditures on the recent spate of economic packages and capital expenditures will also provide the upside.
On the other hand, the assessment on inflation has relatively soured – now annual average on Headline CPI inflation is expected at 5.7% compared to 5.1% previously. But, the negativity stops there and the communication is clear on the reasons why the RBI has and would continue to look through the relatively higher inflation. First, the RBI continues to point out that temporary supply shocks have been the root cause of inflation and demand pull pressures remain almost absent. This is a continuation of the RBI communication in the previous policy as also in the run up to this policy. Further, the RBI, again like many other central banks in advanced economies, is looking at a flexible inflation targeting, rather than the 4% target.
Finally, there is once again a confirmation from the RBI that any pre-emptive tightening of interest rates will kill the “nascent and hesitant” recovery that is “trying to secure a foothold in extremely difficult conditions”.
There is some change in how the RBI will handle the surplus liquidity. The Variable Rate Reverse Repo (VRRR) is being made more potent to suck out the overnight liquidity as the RBI is looking to ramp up the announced size of auction under this instrument in a phased manner to Rs 4 trillion by September 24, 2021 compared to the current size of Rs. 2 trillion. Some market participants have pointed out that this is indeed normalization. However, the communication from RBI is clear that this remains a part of the overall liquidity and is not being taken out of the system in totality.
Overall, I think this policy has tried to strike a delicate balance between the larger goals of the monetary policy and the need of the hour. However, seeing the current growth and inflation dynamics I do not see a realistic chance of policy normalization in the remainder of FY22.
(Indranil Pan is Chief Economist at YES Bank. Views expressed are the author’s own.)