The Reserve Bank of India (RBI) plans to remain in the liquidity absorption mode, and the variable reverse repo rate (VRRR) auctions should not be seen as a signal either for withdrawal of liquidity or lift-off of interest rates, deputy governor Michael Debabrata Patra said on Thursday.
“Signals of the latter will be conveyed through the stance that is articulated by the MPC (monetary policy committee) in its future resolutions. We don’t like tantrums; we like tepid and transparent transitions – glide paths rather than crash landings,” Patra said, speaking at the Confederation of Indian Industry’s (CII) financial markets summit.
The deputy governor observed that the essence of flexible inflation targeting is to protect growth by minimising the sacrifice of output, which is the ‘price’ of price stability. In India, it is achieved by five specific features, which include a dual mandate, an inflation target defined in averages rather than as a point, achievement of the target over a period of time, a reasonably wide tolerance band around the target and failure being defined as three consecutive quarters of deviation of inflation from the tolerance band.
In May and June, inflation overshot the upper tolerance band. Patra said with cost push pressures impacting core inflation and inflation expectations, the MPC’s dilemma became sharper because firms showed evidence of some improvement in pricing power and the drivers of inflation were shifting.
“Time will tell if the call is true. Data arrivals vindicate the MPC’s stance, with inflation having moderated into the tolerance band, and growth in the first quarter in almost perfect alignment with the RBI’s forecast,” Patra said.
He defended the RBI’s decision to keep the reverse repo rate at 3.35% while the repo stays at 4%. In normal times, the reverse repo rate is mechanistically linked to the repo rate by a fixed margin, as is the marginal standing facility (MSF) rate. Pandemic times are, however, drastically different and call for out-of-the-box responses, Patra said. “This is accentuated by the fact that the credit channel of transmission broke down because of muted demand and risk aversion, and the RBI decided to operate through other segments of the financial markets to keep the lifeblood of finance flowing,” he said.
Patra said that the suggestion to adjust the reverse repo rate asymmetrically relative to the repo rate had come from an external member of the MPC and that market participants also gave the RBI similar feedback in pre-policy consultations. “In effect, the RBI followed this counsel and the written resolutions of the MPC not just in letter, but also in spirit. By no means is the asymmetric corridor cast in stone. As normalcy returns, markets will return to regular timings,” he added.