The Reserve Bank of India (RBI) has not really gotten in any surprise on the rates front, which is good for the market. The unchanged stance on repo and reverse repo rate does assuage the market. Given that other macroeconomic expectations are largely balanced with inflation to move downwards, it can be expected that there will be no change in the repo rate for the rest of the financial year.
The GDP outlook was expected to change upwards, but the RBI has retained 9.5 per cent forecast. It is sanguine on investment recovery, as well as the services sector. This is significant as the CMIE data on investment was not too positive for the first half of the year. The opening of the economy post the nationwide lockdown to slow down the coronavirus has finally covered the services sector. Interestingly, due to the base effect of last year, the quarterly growth rates for the year would be declining from 7.9 per cent in Q2 to 6.8 per cent in Q3 to 6.1 per cent in Q4. This should not be interpreted as slowing down growth due to these statistical effects.
Inflation forecast has been, on expected lines, moderated to 5.3 per cent from 5.7 per cent. Here the interesting thing is that the quarterly inflation rates would move down from 5.1 per cent in Q2 to 4.5 per cent in Q3 but rise to 5.8 per cent in Q4. Hence, this means that the base effects will finally erode with prices moving up. The RBI here has rightly pointed out that the two oils--edible and crude--would be the main risk this year going ahead. This is probably the biggest risk for the economy as it does affect input prices and finally growth.
The important message awaited was the RBI take on liquidity. Here the reiteration that the RBI believes in gradualism is important. To regulate liquidity, the RBI will not be holding any more GSAP auctions but would continue with OMOs and Operation Twist to regulate the market yields in particular. This is a positive step as it ensures liquidity does not shoot up but yields remain regulated.
The RBI will now be quite aggressive in the V3R-variable reverse repo rate auctions for 14 days that will help absorb excess liquidity in the system. The RBI has rightly emphasized that the V3R can also be called the voluntary reverse repo rate auctions as the purpose is to allow banks to put their surplus funds which today is nearing Rs 10 lakh crore in these auctions and earn something higher than 3.35 per cent. There is hence a calendar drawn out till December, which progressively absorbs more liquidity from the system starting with Rs 4 trillion and going up to Rs 6 trillion. This again is the ideal way of going about the absorption process.
The final message-- which is important--to be taken is that the RBI has just about started the reversal process, but it is going to be a very gradual one. There will not be any shock to the market, with the calendar being drawn out. By assuring the market that the RBI will use OMOs and Operation twist at any point of time it has assured the market on the yield curve. There should ideally be no kneejerk reaction in the market. The 10-year bond has moved up from 6.27 to 6.28 per cent, but maybe we should not read too much into this.
(Madan Sabnavis is an independent economist. The views expressed are his own.)