Monetary policy review: Rs 17.2-trillion liquidity bazooka

Since the pandemic began, the RBI has made an announced liquidity injection of Rs 17.2 trillion, or 8.7 per cent of GDP, into the banking system (MPR report, pp82). Of this, the unconventional liquidity measures amount to approx. Rs 9.1 trillion, implying the residual Rs 8.1 trillion is mostly conventional liquidity injection like OMO at Rs 3.7 trillion. Juxtapose this with nominal GDP loss at Rs 6.1 trillion for FY21 implying the liquidity injection should ideally be at Rs 6 trillion (velocity is assumed at one). This indicates the enormity of RBI liquidity management and the markets need to appreciate that the scale down of liquidity overhang from Rs 17.2 trillion to Rs 6 trillion is a journey that also must be attained with least disruption!

 

Interestingly, the liquidity management is also hamstrung by the RBI unwinding of forward premia by as much as $23 billion in the last couple of months. If the RBI wants to discourage liquidity injection in lieu of such unwinding, as the MPR notes, the “resultant rollover can trigger a vicious cycle of higher inflows and even further increase in the forward premia”. In fact, in the first half of FY22, the net forex purchases by the RBI were as much as Rs 3 trillion and the currency leakage contrary to historical trends was also minimal. Given all this, the RBI attempt to bring down the reverse repo to Rs 3-4 trillion in December from current Rs 8.8 trillion will be most challenging as a large part of such is determined by autonomous liquidity inflows.  It must be noted that a large liquidity overhang is inconsistent with a reverse repo rate hike as and when it happens!

 

We reiterate that the analytical underpinnings of many of the issues discussed in the RBI’s policy statements emanate from RBI Monthly Bulletin and reports like MPR. Therefore, market participants would be better advised to peruse these documents for an informed discussion and debate.

Meanwhile, global recovery has subsided with the rapid spread of the delta variant of Covid-19, including in some countries with high vaccination rates. Also, as the Federal Reserve calculates its tapering time frame, markets are expected on tenterhooks. If we add the evolving situation in China, the coming months will only reinforce the volatile trends in the external sector.

 

On the domestic front, there is still some way to go before growth impulses attain the critical mass.

 

On the inflation side, CPI inflation is projected at 5.3 per cent for FY22.

 

On the regulatory front, the RBI has continued its agenda of introducing technology in the financial system. The measure to introduce digital payment in offline mode enables retail digital payments even in situations where internet connectivity is low. The enhancement of limits under IMPS indicates ticket value under retail payment is rising, indicating wider acceptability.

 

In similar vein, setting up of Payments Infrastructure Development Fund (PIDF) to encourage deployment of acceptance infrastructure and create additional touch points and geo-tagging of touch points will be important in monitoring and scaling of infrastructure in the financial sector. The RBI has also opened its Sandbox for On Tap application for themes of cohorts earlier closed. This move will ensure that technology obsolescence is addressed at the earliest.

 

Overall, the policy has taken a cautious wait-and-watch stance while ensuring domestic recovery is nurtured assiduously through all policy channels.

The author is Group Chief Economic Advisor, State Bank of India. Views are personal