Monetary policy: Is the RBI MPC being too clever by half?

It can be argued, out of common sense, that those who desperately needed liquidity during the pandemic got it, which should prompt RBI to increase the repo rate by a small amount

“When you can’t dazzle them, try baffling them” is a well-known witticism.  And of late, the Reserve Bank of India (RBI) has been espousing this pearl of new-age wisdom.

To put it bluntly, when your words and actions don’t quite match, either you are not clear about what you want to do, or you’re trying to baffle people. This is the inescapable conclusion from the RBI’s Monetary Policy Committee (MPC) action on Wednesday. which decided to retain the repo rate at 4% for the 9th time in a row and retained the reverse repo rate at 3.35%. 

No action is also action, as a former Indian prime minister once said. 

According to the RBI Governor “the recovery of aggregate demand hinges on private investment, which is still lagging” and while the economic recovery following the second Covid wave is gaining traction, but “it is not yet strong enough to be self-sustaining and durable”.

This, he said, underscores the vital importance of continued policy support. 

Even if we accept this argument at face value, there are questions to be asked about what this continued policy support will achieve that it has not already achieved. 

If the private sector is still not investing, despite the wave of liquidity the RBI has provided, then one must consider whether there are other factors dampening their spirits.

Whatever the RBI might say about being accommodative and providing necessary support, its actions say that it seems to agree that simply providing liquidity is not working in encouraging the private sector. 

Although it has kept the reverse repo rate unchanged, it has been tweaking the variable reverse repo rate (VRRR) auctions to soak up an increasing amount of liquidity.

The VRRR auction amount was progressively increased to Rs 6 lakh crore by early December, and the RBI said it would increase the 14-day VRRR auction amounts on a fortnightly basis, to Rs 6.5 trillion on December 17 and Rs 7.5 trillion on December 31.

So, which is it? Does the economy need policy support in terms of cheap liquidity or is the excess liquidity starting to do more harm than good? 

Given that inflation is still not low enough for comfort and that households perceive it to only go up, it would not be incorrect for the RBI to come down on the side of all this liquidity doing more harm than good.

Households’ median inflation perceptions for the next three months and for the year ahead increased by 150 and 170 basis points, respectively, to 12.3% and 12.6%, according to the RBI’s latest round of its Inflation Expectations Survey of Households.

But if that is the decision, the RBI should say as much. If the curbing inflation versus boosting growth debate is tilting towards curbing inflation, the implication is that the RBI is reasonably confident that growth can handle itself. 

If that’s the case, then why all the doom and gloom from its Deputy Governor Michael Patra who is of the opinion that output will take years to recover?

The other question is this: If the RBI is indeed pulling back on its liquidity efforts, is it doing so fast enough? Why this snail-like approach?

It can be argued, out of common sense, that those who desperately needed liquidity during the pandemic got it. Those remaining either don’t seem to want as much of it, or can afford to pay a little more for it. 

In which case, the RBI can just go right ahead and increase the repo rate by a small amount. There’s no need for shadow dancing. 

I am saying all this because t’s not quite clear what the RBI is trying to signal. In trying to sound supportive while at the same time doing what is needed, the overall message it is giving out is designed to baffle. 

Or wait, is that the strategy? Can’t dazzle, so will baffle.