RBI commits to OMO calendar, leaves key policy rates and stance unchanged

Despite the surge in Covid-19 infections, the growth target also remained unchanged at 10.5 per cent for the fiscal, but inflation was tweaked upwards slightly

The Reserve Bank of India (RBI) today took a step toward formalising its own version of quantitative easing, committing to support the bond market through secondary market purchases, starting with Rs 1 trillion in the first quarter. Though the central bank said this will be in addition to open market operations (OMOs), in essence, this is a calendar for OMOs, a long-standing demand from the bond market.

The six-member monetary policy committee also voted unanimously for a status quo on the benchmark rate “for as long as necessary to sustain growth on a durable basis and continue to mitigate the impact of Covid-19 on the economy, while ensuring that inflation remains within the target going forward.”

The MPC came up with a new policy tool kit called ‘secondary market G-sec acquisition programme’. or G-SAP 1.0. It is akin to the existing open market operations (OMO) through which the RBI bought a net Rs 3.13 trillion of bonds from the secondary market in the last financial year. The G-SAP would be part of the overall liquidity management framework for the year, the RBI said.

The G-SAP programme, which will start on April 15 with Rs 25,000 crore bond buying, will enable stable and orderly evolution of yield curve, help the market to plan their liquidity requirement better, and will ensure “congenial financial conditions for the recovery to gain traction,” the RBI governor said.

Deputy governor Michael Patra added that such an upfront assurance “is very much like what the central banks are doing across the world where they are buying into assets of various types, except that the RBI is buying the highest quality collaterals in the form of government securities”.

Deutsche Bank economist Kaushik Das termed the programme as a “soft yield curve control” strategy that would continue for the next few quarters.

However, answering to a Business Standard query, the RBI governor clarified that the central bank was not trying to bring down the yields, but was providing enabling environment for the markets to do so.

“We are mindful of all the aspects of the liquidity situation and maintaining financial stability. There are many conflicting objectives which the central bank is required to manage, and there are trade-offs. We are quite confident that we will be able to sort of take a balanced tone and I think ultimately it's a judgement call,” said Das.  

“The G-SAP will almost serve the purpose of a OMO calendar, which had been on the bond market’s wish-list for a long time,” said Siddhartha Sanyal, chief economist of Bandhan Bank.

The bond and rupee markets showed opposite reactions to the policy.
 

Reacting favourably to the policy, the 10-year bond yields fell as much as 6.06 per cent, but closed at 6.08 per cent, 4 basis points lower than its previous close. It had ended the last financial year at 6.18 per cent.

The rupee fell more than 1.5 per cent to close at 74.55 a dollar.

According to currency dealers, the RBI’s insistence on keeping rates low at a time when yields are hardening in developed markets may have unwounded some carry trades as investment in India may look relatively unattractive for foreign investors.

The central bank kept its growth target nearly unchanged at 10.5 per cent for the current financial year and tweaked the inflation forecast slightly upwards, adding that it expects consumer price index (CPI) based inflation at 5 per cent in the fourth quarter of 2020-21, 5.2 per cent in the first quarter of the current fiscal, 5.2 per cent in Q2; 4.4 per cent in Q3; and 5.1 per cent in the fourth quarter with risks broadly balanced.

“The focus must now be on containing the spread of the virus as well as on economic revival - consolidating the gains achieved so far and sustaining the impulses of growth in the new financial year (2021-22),” Das said in his policy statement streamed online.

Overall, the domestic markets were happy with the policy.

“The RBI policy statement is a clear commitment to assuage uncertainties in the market through guaranteed, continued liquidity support and explicit guidance to navigate through the current Covid surge, the duration of which is uncertain,” said State Bank of India chairman Dinesh Khara.

However, a prolonged easy money policy brings with it risks of inflation in the medium term. The 3-month and 1-year household inflation expectations rose by 80 basis points (bps) and 10 bps respectively in the March 2021 RBI survey on Households’ Inflation Expectations. The Business Expectations Index showed more optimism, rising to 119.6 in the Q1:2021-22 from 114.1 in Q4:2020-21.

According to HSBC, the core inflation may remain elevated at 5.5-6 per cent range in FY22, which may remain sticky.

“Elevated inflation and negative real rates can create their own distortions such as encouraging investment in physical assets such as gold, which in turn can pressure external balances (via high gold imports) and lower potential growth,” said HSBC chief India economist Pranjul Bhandari, adding that the RBI may gradually exit from the loose monetary policy towards the end of 2021 as the pandemic subsides and vaccination drive reaches a critical mass.

The RBI said it will also increase the scope of its variable rate reverse repo (VRRR) auctions with increased tenure. “This is part of our liquidity management and not to be interpreted as liquidity tightening,” the RBI governor said. The on-tap targeted long term repo operations (TLTRO) will also continue till September 30 to help ease liquidity needs of the system. It had come to a close on March 31.

Among other liquidity boosting measures, the RBI extended the special liquidity facility for All India Financial Institutions such as Nabard, Sidbi, NHB and EXIM Bank.

The RBI said payments banks can now have a per account balance of Rs 2 lakh, doubled from Rs 1 lakh earlier. The RBI will be constituting a committee on asset reconstruction companies (ARC) to undertake a comprehensive review of the sector and recommend measures for their growth.

Banks can on-lend through non-banks till September 30 to meet their priority sector lending (PSL) targets. The PSL loans against warehousing receipts have also been increased to Rs 75 lakh, from Rs 50 lakh earlier. There will also be a financial inclusion index to be developed by the RBI.

The central bank brought in some measures in the payment space and allowed NBFCs, card networks and prepaid instrument providers to access the centralized payment systems such as RTGS and NEFT that were being used by banks only.

Interoperability of Prepaid Payment Instruments has now been made mandatory in the policy.