Statsguru: Inflation to bond yields, key data ahead of MPC meeting

The Reserve Bank of India’s monetary policy committee (MPC) will meet this week to decide whether to further reduce the policy repo rate or not. This will not be an easy decision. While the economy battling with the pandemic shock needs support, inflation continues to remain above the central bank’s target band.

A big challenge is policy transmission as the long-term interest rates in the economy (government bond yields) remain sticky. Chart 1 shows that after successive rate cuts earlier this year, only short-term interest rates have come down. Shorter duration papers have seen bigger corrections in yields.

See the movement in 1-month treasury bill rate, and its faster decline compared to the 1-year T-bill. This suggests that the market is interested in playing the short-term game.

A global comparison further underlines the risk aversion: Long-term interest rates fell faster in most other economies after liquidity support measures were announced (chart 2).

A cut in repo rate and weak credit demand should bring down interest rates in the economy. But its efficacy gets restricted to some extent by deposit rates, which face competition from the government’s small saving instruments. The one-year post office deposit is offering 0.4 percentage points more than the one-year fixed deposit in Indian banks (chart 3).

Having said that, and bucking the pre-Covid trend, the transmission to lending rates has improved in recent period. Chart 4 shows that the drop in SBI’s external benchmark-linked lending rate has been equal to the drop in repo rate this year.

Also, RBI’s balance sheet has expanded faster than usual after it started responding to the Covid crisis. This is also because of interventions in the foreign exchange market, which has pushed up reserves (chart 5) and increased liquidity in the system. The MPC’s view on the extent to which the excess liquidity and negative real interest rates will affect inflation outcomes will perhaps be an important factor in the decision-making.

StatsGuru is a weekly feature. Every Monday, Business Standard guides you through the numbers you need to know to make sense of the headlines                                                           Compiled by BS Research Bureau