Expect status quo on rate and no change in stance

As the festival season approaches, followed by elections, state and national, there will be pressure on liquidity since cash with the public will rise

On September 20, the Federal Reserve left its target federal funds rate unchanged, but continued with its hawkish stance and projected another rate hike by the end of the year and a tighter monetary policy through 2024. Since March 2022, it has raised its benchmark rate 11 times — the fastest pace of tightening since the early 1980s.

Around the same time, in a surprise move, the Bank of England ended the run of 14 straight interest rate hikes since the end of 2021, leaving the base rate unchanged at 5.25 per cent.

It was a close call, with Governor Andrew Bailey using his casting vote to pause. There were arguments to raise it again but, in the end, the governor was convinced that inflation was easing. The rates could stay at the current level for a longer period.

The European Central Bank raised its key interest rate by 25 basis points (bps) to a record high of 4 per cent on September 14 and hinted at maintaining the current levels to contain inflation. One bp is a hundredth of a percentage point.

Even though it is not in the same league, Turkey’s central bank has hiked its key interest rate by 5 percentage points to 30 per cent to fight double-digit inflation. In June, Turkey had lifted its key interest rate for the first time in over two years to tame skyrocketing inflation and a slipping currency.

Meanwhile, the Bank of Japan left its monetary policy unchanged after its latest meeting — rates at -0.1 per cent and the 10-year Japanese government bond yield capped around zero. The ultra-loose monetary policy makes Japan an outlier among major central banks, which have raised interest rates in the last two years to control spiralling inflation.

Among others, Canada, Australia, New Zealand and South Korea held their policy rates unchanged in their latest meetings. The Central Bank of Brazil, however, had cut its benchmark interest rate by 50 bps in August after almost a year-long pause, and Poland started its rate-cutting cycle with a 75-bps cut in its September meeting after keeping it on hold since October 2022. The People’s Bank of China, too, cut rates, while the Bank of Russia, in an off-cycle meeting in August, raised its key rate by 3.5 percentage points and followed it by another 1 percentage point hike to 13 per cent in September.

What will the Indian central bank do this week?

In August, the Reserve Bank of India (RBI) continued with the pause it had pressed in April, after raising its policy rate from 4 per cent to 6.5 per cent since May 2022 to fight rising inflation. But unlike June, when the RBI had found that “the uncertainty on the horizon appears comparatively less and the path ahead somewhat clearer”, and that “the Indian economy and the financial sector stand out as strong and resilient in a world of unprecedented headwinds and swift cross-currents”, in August, the undertone of the policy was hawkish.

The last rate hike happened in February — by 25 bps, the lowest since the rate-hiking cycle started. That took the policy rate to 6.5 per cent, last seen in February 2019, when the annual consumer price index (CPI) inflation was 2.57 per cent. While raising the rate in February, the policy statement had not offered any forward guidance. In the post-policy press conference, RBI Governor Shaktikanta Das had simply referred to a “mood of optimism”.

The CPI inflation rate in India rose to a 15-month high of 7.44 per cent in July before easing to 6.83 per cent in August. The stiff rise, primarily driven by food prices, happened after it had dropped to its 25-month low of 4.25 per cent in May.

The RBI’s flexible inflation target is 4 per cent plus/minus 2 percentage points. In the aftermath of the pandemic, it was tolerating inflation crossing the higher end of the band. Now, the focus is on bringing it down to the 4 per cent target, on a durable basis, to ensure sustainable growth.

While announcing the August policy, the governor had brushed aside the sudden rise in CPI inflation and looked through this as an “idiosyncratic shock”, but raised the inflation projection for the year. Assuming a normal monsoon, the CPI inflation projection forFY24 was hiked to 5.4 per cent in August after paring it by 10 bps to 5.1 per cent in June. The projection for the second quarter of FY24 was raised by 1 percentage point to 6.2 per cent; the rise for the third quarter was by 30 bps to 5.7 per cent; while the fourth quarter projection remained unchanged at 5.2 per cent. That was also the estimate for the first quarter of FY25.

Even though a new risk to global financial stability stems from the commodity markets as crude prices crossed $90 per barrel, a 10-month high, against the RBI’s estimate of $85, the central bank seems to be confident that the CPI inflation will fall sharply in September since food prices are easing. The non-food, non-oil core inflation also remained steady at 4.9 per cent in August. Most analysts estimate the FY24 inflation to be slightly higher than what the RBI has projected. Will it raise the inflation estimate? Probably not, even though higher oil prices will impact both retail and core inflation.

Against this backdrop, the RBI is set to continue with the status quo on rate. Will it change the stance — withdrawal of accommodation? No.

Surplus liquidity in the system is a fodder for fuelling inflation. In August, the RBI raised banks’ cash reserve ratio (CRR), or the money that the commercial banks keep with the central bank on which they don’t earn any interest, to soak up liquidity. It was an extremely short-term measure. On top of the existing 4.5 per cent CRR, the RBI asked the banks to maintain an incremental 10 per cent CRR on the increase in net demand and time liabilities, a loose proxy for deposits, between May 19 and July 28.

It had absorbed around Rs 1.1 trillion through this route. One-fourth of this was released on September 9, followed by another quarter on September 23; the rest will flow back on October 7.

Meanwhile, the liquidity deficit in the system in the third week of September peaked at Rs 1.47 trillion, the highest since April 2009. The advance tax outflow contributed to it.

Typically, banks borrow from the marginal standing facility (MSF) window of the RBI at 6.75 per cent when they need money and park excess liquidity at the standing deposit facility (SDF) window at 6.25 per cent.

The MSF-SDF is the liquidity adjustment facility (LAF) corridor, replacing the earlier repo-reverse repo corridor. The RBI occasionally infuses money through variable repo rate (at 6.5 per cent or above) and absorbs liquidity through variable reverse repo rate (below 6.5 per cent). Recently, it has sold bonds in small quantities through screen-based open market operations (OMOs) to generate liquidity.

As the festival season approaches, followed by elections in various states and at the Centre, there will be pressure on liquidity since cash with the public will rise.

There are many instruments at the RBI’s disposal to manage liquidity, but it will stick to its stance since its objective is to bring down CPI inflation to 4 per cent. At the same time, it has to ensure that adequate resources are available for growth and the orderly completion of the government’s record Rs 15.43-trillion gross market borrowing programme in FY24. Incidentally, between November and January, Rs 2.81 trillion worth of bonds will be redeemed.

The RBI is also expected to keep its estimate for the real gross domestic product growth for the year unchanged at 6.5 per cent.

The writer is an author and senior advisor to Jana Small Finance Bank Ltd. His latest book is 'Roller Coaster: An Affair with Banking'
 

To read his previous columns, log on to https://bankerstrust.in
 

Twitter: @TamalBandyo