Omicron impact concern forces RBI to keep reverse repo rate unchanged

Variable rate reverse repo auction seems to be the central bank's mode to fine tune excess liquidity.

The monetary policy committee (MPC) of the Reserve Bank of India on Wednesday kept the key interest rate (repo) unchanged at 4% for the ninth straight policy meeting and maintain an accommodative stance—a policy statement widely expected.

The market was split on whether there would be a hike in the reverse repo rate: a view echoed by one MPC member, Jayanth Varma. The gap between the repo and the reserve repo rate was widened at the onset of the pandemic in March 2020, and some economists believe that there was a case to narrow the gap as a step towards normalising the ultra-loose monetary policy stance.

The RBI, however, decided to leave the reverse repo rate unchanged.

“Once this Omicron came the global markets became volatile,” said A Prasanna, head-fixed income research, ICICI Securities PD, referring to a new variant of the coronavirus.

“We do not have complete information though initial information suggest it could be a mild variant but still I think there is lot of uncertainties. When normally when faced with uncertainties, the safe option is to maintain status quo,” Prasanna told Business Standard.

Omicron featured five times in the RBI governor’s Shaktikanta Das’ thirty-minute statement on the outcome of the MPC’s meeting in Mumbai.

Das said the MPC regarded the accentuation of headwinds emanating from global developments as the main risk to the domestic outlook. He also said though the Indian economy is relatively well-positioned on the path of recovery, but it cannot be immune to global spillovers or to possible surges of infections from new mutations of the coronavirus.

Some market experts hailed the decision of not touching the reverse repo as any hike in the rate would have implications on the other rates too, which could have been counterproductive when economic recovery is yet to become sustainable.

“The moment the reverse repo is touched there can be a severe implication on how most of the other interest rates react in the market,” said Indranil Pan, chief economist Yes Bank.

“I am not suggesting that the corridor will remain as wide as this forever. Given the fact that you have significant uncertainties on growth, which therefore does not establish a clear base point for interest rates to increase across the board, you cannot really do much about the reverse repo at this point,” Pan said.

Enhancing VRRR

The variable rate reverse repo auction seems to emerge as a preferred mode for the central bank to fine tune the excess liquidity situation, which in turn have an impact on short-term rates.

“The objective is to reestablish the 14-day VRRR auction as the main liquidity management operation,” Das said while adding that enhancing VRRR auction amount to Rs 6 trillion by December 3, resulted in overnight collateralised money market rates mildly firming up in recent times.

RBI has now further enhanced the 14-day VRRR auction amounts – Rs 6.5 trillion on December 17 and Rs 7.5 trillion on December 31. From January 2022 onwards, liquidity absorption will be undertaken mainly through the auction route, RBI said.

“They are continuing their liquidity adjustments through the VRRR auctions. That seems to be the primary route for them to tighten policy rather than rate hikes for now,” Prasanna said.

While the central bank has retained the inflation forecast for FY22 at 5.3%, but revised the projection for the current quarter upward, from 4.5% to 5.1%. For the fourth quarter, CPI inflation is seen at 5.7%, as compared to 5.8% projected earlier.

CPI inflation for both the first and second quarter of the next financial year is projected at 5%.