RBI begins policy normalisation; maintains status quo on rates

Retains accommodative stance, FY22 growth forecast; lowers inflation projection

The Reserve Bank of India (RBI) on Friday kept its policy rates and stance unchanged, but decisively moved to withdraw excess liquidity from the system through its least disruptive liquidity management tool.

The six-member monetary policy committee (MPC), headed by RBI Governor Shaktikanta Das, voted unanimously to keep the repo rate at 4 per cent and the reverse repo rate at 3.35 per cent.

The stance would remain ‘accommodative’ for “as long as necessary to revive and sustain growth on a durable basis and continue to mitigate the impact of Covid-19 on the economy”, the central bank said. Five of the six MPC members favoured the stance, with external member Jayanth R Varma voting against it once again.

The RBI lends money to banks at the repo rate, and offers the reverse repo rate while absorbing their excess funds. Surplus liquidity rose to a daily average of Rs 9.5 trillion as of October 6, with the potential liquidity overhang amounting to more than Rs 13 trillion, the RBI said.

Therefore, the central bank said it would no longer commit to buying secondary market bonds under its government securities acquisition programme (G-SAP), through which it has injected Rs 2.2 trillion of liquidity in the system (out of the total Rs 2.37 trillion injected through bonds), and would absorb a higher quantum of liquidity gradually through its 14-day variable rate reverse repo (VRRR) auctions.

“Given the existing liquidity overhang, the absence of a need for additional borrowing for GST (goods and services tax) compensation, and the expected expansion of liquidity in the system as government spending increases in line with budget estimates, the need for undertaking further G-SAP operations at this juncture does not arise,” it said.

VRRRs would reduce the surplus liquidity to Rs 2-3 trillion by the first week of December, in what could be considered as the first step towards normalisation of the RBI’s ultra-loose monetary policy.

RBI Deputy Governor Michael Patra said in the policy conference that the central bank was following a step-wise approach to policy normalisation.

“The first is the stopping of liquidity; the second is moving liquidity from fixed-rate reverse repo to the auctions... On the next steps, let me assure you, the RBI has all the adequate instruments. The issue is not of instruments but of timing and calibrations,” Patra said.

Liquidity fine print

By the first week of December, the quantum absorbed under VRRR would rise to Rs 6 trillion, from Rs 4 trillion conducted on Friday. Interestingly, the cut-off of the VRRR auction came in at 3.99 per cent, almost the same as the repo rate. Patra said the cut-off was high because the RBI was in a “passive mode” and was accepting the cut-off that market auctions were throwing up in the process of price discovery.

HSBC economists Pranjul Bhandari and Aayushi Chaudhary wrote the RBI’s steps would limit the addition to durable liquidity and push effective rates up, followed by a reverse repo rate hike over December and February. The markets would not be disrupted by the RBI moves, the duo noted.

“We continue to expect the reverse repo rate to be increased by 40 bps between December and February,” said Anubhuti Sahay, chief economist of Standard Chartered Bank.  

“While the statement was more dovish than expected, more detailed forward-looking guidance is likely to shape expectations over the next few meetings,” Sahay said.

The RBI will also introduce 28-day VRRR auctions and will continue to fine-tune liquidity operations, such as seven-day VRRRs or operation twist and open market operations (OMO), depending on the need.    

“The RBI will ensure that there is adequate liquidity to support the process of economic recovery. The Reserve Bank will continue to support the market in ensuring an orderly completion of the borrowing programme of the government,” the RBI governor assured the market.

“Further, our focus on orderly evolution of the yield curve as a public good also continues,” he said, adding the liquidity measures were not unilateral, but were arrived at after consultation with market participants.

“Our entire approach is one of gradualism. We don’t want suddenness, we don't want surprises,” Das said in his opening remarks.

The bond market, though, expressed its anxiety by pushing up yields. The 10-year bond yields closed at 6.3178 per cent, a level last seen on April 17, 2020, from its Thursday’s close of 6.267 per cent. The rupee, meanwhile, reached 75.16 in the intraday trade, but closed at 74.99 a dollar amid RBI intervention. The rupee had closed at 74.79 a dollar on Thursday.

Growth and inflation

The central bank kept its growth forecast unchanged for the fiscal year at 9.5 per cent, but lowered the inflation forecast to 5.3 per cent from 5.7 per cent earlier.

The monetary policy resolution said the key driver to softer inflation would be moderation in food prices even as fuel inflation has edged up. However, core or CPI inflation, excluding food and fuel, remained sticky. Going forward, softer vegetable prices, a sharp deflation in gold prices, and muted housing inflation would help contain inflationary pressures. The central bank now expects inflation at 5.1 per cent in Q2, 4.5 per cent in Q3, 5.8 per cent in Q4 of 2021-22, and 5.2 per cent in the first quarter of the next financial year.

“We are watchful of the evolving inflation situation and remain committed to bringing it closer to the target in a gradual and non-disruptive manner,” the policy statement said.

“Efforts to contain cost-push pressures through a calibrated reversal of the indirect taxes on fuel could contribute to a more sustained lowering of inflation and an anchoring of inflation expectations,” said the RBI governor.

The central bank also saw firm signs of growth. The Q1 growth number of 20.1 per cent was a tad lower than the RBI’s estimate of 20.4 per cent, “but exhibited resilience of the economy in the face of the destructive second wave of Covid-19”.

High frequency indicators suggested a recovery in aggregate demand in August-September. The ebbing of infections, together with improving consumer confidence, supported private consumption. The pent-up demand and the festival season should give further fillip to urban demand in the second half of the financial year, while rural demand shows resilience in the agriculture sector, the RBI said.

“Improvement in government capex, together with congenial financial conditions, could bring about an upturn in the much-awaited virtuous investment cycle,” the RBI said, adding investment activity was witnessing some revival.

The RBI’s survey showed that capacity utilisation in the manufacturing sector, which declined sharply in the first quarter under the second wave, “is assessed to have recovered in Q2 and further improvement is expected in the ensuing quarters”.

The RBI expects real GDP growth at 7.9 per cent in Q2, 6.8 per cent in Q3, and 6.1 per cent in Q4 of 2021-22. Real GDP growth for the first quarter of 2022-23 was projected at 17.2 per cent.

Other policy measures

The central bank introduced a regulatory sandbox for the prevention and mitigation of financial frauds, and allowed on-tap applications for three cohorts on retail payments, cross-border payments and MSME lending.

An integrated ombudsman scheme for certain categories of NBFCs having higher customer interaction was introduced, and the RBI extended deadlines on some liquidity measures for small finance banks, NBFCs as well as for states and Union Territories.