Uncertainty, however, lies in the speed and quantum of reversal of accommodation and the subsequent narrowing of repo-reverse repo corridor.
By Churchil Bhatt
Gone are the days when policy makers talked in riddles and habitually surprised markets using “shock and awe” tactics. Former Fed Chairman Alan Greenspan once said in a lighter vein, “Since I’ve become a central banker, I have learned to mumble with great incoherence, if I seem unduly clear to you, you must have misunderstood what I said”. Since then, central bank communication has evolved significantly. Policymakers, including RBI, now use forward guidance as a communication tool to nudge markets and further their objectives.
RBI in October MPC has begun to fine-tune excess policy accommodation. In doing so, it has struck a difficult conversation with markets. Taking away any policy support from markets is akin to taking a cookie away from a child. Neither the child nor the guardian takes pleasure in the process, and in all fairness, even the cookie seller stands to lose. In other words, in absence of nuanced communication, even lessening of existing accommodation can elicit strong withdrawal symptoms from markets, similar to what we experienced during “Taper Tantrum”.
That is because Efficient Markets take it upon themselves to weave into today’s asset prices all future possibilities. In that process, markets often amplify price reaction to every small Central Bank signal. During times of high uncertainty such sharp market moves, if any, may in turn have adverse consequences for the real economy, working contrary to Central Bank’s intentions. Thus as we gradually emerge out from the pandemic-era stimulus, the RBI will have to manage market overreaction as well as the real economy.
In this policy, the MPC kept its policy rates and stance unchanged. While the MPC retained its FY2022 GDP growth forecast at 9.5%, the downward revision of 40 bps to FY2022 inflation projection on the back of lower food prices is assuring, even though crude oil and other commodity prices remain a threat. On the action front, the RBI signalled gradual “Tapering” of liquidity by extending the VRR amount, which will likely include an extension of tenor – a move in line with markets’ expectations. While the RBI refrained from committing any GSAP amount to support bond yields, their emphasis on an “orderly evolution of yield curve” has comforted Bond markets.
In the context of the current macroeconomic climate, there is more or less consensus regarding the direction in which monetary policy is headed. Uncertainty, however, lies in the speed and quantum of reversal of accommodation and the subsequent narrowing of Repo-Reverse Repo corridor. In order to manage market volatility during the policy corridor shift, RBI is likely to provide comforting market guidance. Almost everyone agrees that RBI is eventually headed towards making Repo rate the operating policy rate. As this expected future unfolds, RBI will use communication as its primary market management tool to underline its nuanced message that a gradual, guided normalisation is not necessarily the end of policy accommodation.
(Churchil Bhatt, EVP Debt Investments, Kotak Mahindra Life Insurance Company. Views expressed are the author’s own.)