Decoupling from US: RBI governor Shaktikanta Das's boldest monetary policy

RBI has the repo rate (the rate at which the RBI infuses liquidity into the system) and the reverse repo rate (the rate at which it sucks out liquidity) unchanged at 4 per cent and 3.35 per cent

When the Reserve Bank of India (RBI) Governor Shaktikanta Das was reading the monetary policy statement, laced with quotes from Mahatma Gandhi and Lata Mangeshkar’s song “Aaj Phir Jeene Ki Tamanna hai”, most analysts (including me) were liberal in using adjectives such as “extra dovish”, “ultra-loose”, “predictable” and a “non-event” to describe the outcome of the three-day meeting of the Monetary Policy Committee (MPC), the central bank’s rate-setting body.

It has left the repo rate (the rate at which the RBI infuses liquidity into the system) and the reverse repo rate (the rate at which it sucks out liquidity) unchanged at 4 per cent and 3.35 per cent, respectively. Anyway, the effective reverse repo rate has risen from 3.4 per cent in August 2021 to 3.9 per cent in February 2022 through a change in the central bank’s liquidity management strategy.

Also, the MPC will continue with the accommodative stance “as long as necessary to revive and sustain growth on a durable basis”.

After a second read of the governor’s statement and the fine print of the policy document, I have changed my opinion.

This is Das’s boldest policy ever. He has decoupled India’s monetary policy from that of the developed markets. It’s an independent policy and not in sync with what the US Federal Reserve and Bank of England have been doing -- both in terms of growth and inflation. Traditionally, the Fed dictates the terms for most of the emerging markets when it comes to monetary policy.

What is the basis of this bold move?

It’s elementary, My Dear Watson: The RBI’s outlook on inflation. Since the December MPC meeting, retail inflation has moved along the estimated trajectory. Indeed, the outlook for crude oil prices is uncertain but the RBI feels food inflation will drop and with the supply bottlenecks easing, the inflation outlook is benign.

The inflation projection for FY22 is retained at 5.3 per cent -- with a 5.7 per cent projection in the March quarter. More important: Assuming a normal monsoon, retail inflation is being estimated at 4.5 per cent in FY23. The break-up is the following: 4.9 per cent in the first quarter, 5 per cent in the second, 4 per cent in the third, and 4.2 per cent in the fourth, “with risks broadly balanced”.

The estimates, particularly for the second half of FY23, are in consonance with the objective of achieving the medium-term target for retail inflation of 4 per cent within a band of +/- 2 per cent, while supporting growth.

But the data has surprised many -- particularly the inflation projection of the last two quarters. Typically, analysts look at the one-year down-the-line inflation projection. If indeed the RBI’s estimate proves correct, the gap between the policy rate and inflation will narrow and there won’t be any need to raise the repo rate during the year. (Most analysts were pencilling in at least three hikes in the repo rate till now.) Das has said the inflation rate estimated is based on detailed analysis and homework, factoring in all risks.

The RBI’s growth projection is 7.8 per cent for FY23. While this is a realistic estimate, many have reservations about the inflation estimate -- particularly, for the second half. Many say it is one percentage point less than what it could be. If they are correct, the RBI has taken a big gamble in this policy.

With the possibility of a rate hike receding for now, both bond and equity markets cheered the policy. This is a smarter way of managing the bond yield for now than talking about bond purchases through open market operations and operation twists, which involve buying long-end debt while selling short-tenor bonds to keep borrowing costs down.

If there is no rate hike in FY23, the celebrations in the bond and equity markets will continue but the interest rate differential between India and the developed markets will put pressure on the rupee but there’s no need to worry too much as we are sitting on forex reserves of $632 billion (as on February 4) and there is enough rupee liquidity in the system. The policy is quiet on the government’s record high borrowing of Rs 14.3 trillion in FY23. Along with the state governments’ borrowing, the requirement will be around Rs 22.5 trillion. (Das has said the government’s borrowing programme may not turn out as large as budgeted.)

We expect the RBI to deal with this at its next policy in April. By that time, the borrowing calendar for the first half of FY23 will be out. In other words, Das has bought time, for now, with a promise for “calibrated and well-telegraphed” action. For now, he is betting big on the inflation estimate. Or, one can say, the governor has played a mind trick to influence and control the thoughts, behavior, and actions of the market to the RBI’s advantage. The central bankers do this. If crude oil prices spoil the party, things will change. If not, I don’t see any rate hike in FY23.

The writer, a consulting editor with Business Standard, is an author and senior adviser to Jana Small Finance Bank Ltd. Twitter: TamalBandyo