Reserve Bank of India Governor Shaktikanta Das had to walk an extra mile to ensure he did not reveal what’s in his mind about the likely policy action two months from now when inflationary pressures would have eased further.
Last year, Governor Das split ranks with central banks to declare that India would tailor policies that its economy requires instead of following its dominant peers on either side of the Atlantic and in Tokyo.
The message that Das left Wednesday may appear muddled, but a closer look would tell you that he’s done with interest rate increases for now, barring dramatic developments.
“The reduction in the size of the rate hike provides the opportunity to evaluate the effects of the actions taken so far on the inflation outlook and on the economy at large,” said Das. “It also provides elbow room to weigh all incoming data and forecasts to determine appropriate actions and policy stance, going forward.”
With growth being weighed down in the inflation-growth balance, the 250 basis points of cumulative increases are sufficient. Ashima Gyoal, an external member, joined Prof. JR Varma in voting against an increase calling for a wait-and-watch approach. A basis point is 0.01 percentage point.
Yet another factor that points to the likely end of this rate increase cycle is the achievement of some key monetary policy goals.”The real policy rate has been nudged into positive territory,” said Das “The banking system has moved out of the Chakravyuh of excess liquidity; inflation is moderating; and economic growth continues to be resilient.”
Over the years, one question that RBI executives consistently dodged was the desirable real interest rate – the rate adjusted for inflation. That has been answered now, albeit indirectly.
With inflation forecast at 5.6% for the next fiscal fourth quarter, the positive real rate is at 90 basis points. RBI research has indicated the desired real rate is 70 to 100 basis points.
When crisis-era monetary policy draws to a close, the next thing to look out for is where the central bank was when it started.
Let’s row back to February 2020. The RBI released its Revised Liquidity Management Framework.
Two key aspects were: 1) A 14-day term repo/reverse repo operation at a variable rate and conducted to coincide with the cash reserve ratio (CRR) maintenance cycle would be the main liquidity management tool for managing frictional liquidity requirements.
2) With the WACR (weighted average call rate) being the single operating target, the need for specifying a one-sided target for liquidity provision of one per cent of net demand and time liabilities (NDTL) does not arise. Accordingly, the daily fixed rate repo and four 14-day term repos every fortnight being conducted, at present, are being withdrawn.
The next meet in April may set the stage for moving the monetary stance to ‘neutral’ with the winding down of about ₹75,000 crore of the Targeted Long Term Repo Operations.
“The more important point is around liquidity,” said Suyash Choudhary, head-fixed income at IDFC Mutual Fund. Apart from LTRO and TLTRO, “the bigger drain will be on account of seasonal currency in circulation rise. This could be of the order of ₹2 lakh crore. Even assuming some modest inflows on forex, this will still take core liquidity close to neutral by early May. This will likely meet the other condition on liquidity for turning the stance to neutral. The modest but continuous OMO sales in the secondary market are somewhat bewildering. If at all, the question will likely soon move to when to expect permanent liquidity infusion from RBI.”
Given that the RBI’s currency forward book is about a third of what it was at the peak and that it is selling some government bonds to suck out liquidity, the stage may be set for the next phase of monetary policymaking.
Inflation targeting was enacted following the recommendation of the Urjit Patel committee. The second Phase was to move to 14-day term repo from overnight ones for liquidity operations.
“The 14-day term repo rate is superior to the overnight policy rate since it allows market participants to hold central bank liquidity for a relatively longer period. More importantly, term repos can wean away market participants from the passive dependence on the RBI for cash/treasury management. Overnight repos under the LAF have effectively converted the discretionary liquidity facility into a standing facility that could be accessed as the first resort and precludes the development of markets that price and hedge risk,” said the Patel panel.
When the end of a crisis coincides with the need to develop markets, the stage may well be set for the next phase of monetary policymaking – a shift to longer-term liquidity management.
