RBI does well to stay accommodative

Pertinently, as Governor Shaktikanta Das observed, the contact-intensive sectors, accounting for a substantial 40% chunk of the economy, are lagging the recovery in others by a mile.

RBI’s continuing accommodative stance and its strategy to start draining liquidity from the system in calibrated fashion is justified. It is true the potential liquidity overhang is currently about Rs 12-13 lakh crore and inflationary pressures may build up. But, the economic recovery is uneven and the output gap still high; the central bank is right in wanting to wait for growth to be entrenched before initiating more normalisation measures like a hike in the reverse repo rate. Pertinently, as Governor Shaktikanta Das observed, the contact-intensive sectors, accounting for a substantial 40% chunk of the economy, are lagging the recovery in others by a mile.

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To address risks relating to excess liquidity, RBI will stop purchases of gilts under the G-SAP or India’s QE, but will continue with OMOs and Operation Twists to ensure liquidity is adequate. It will continue to soak up liquidity via the VRRRs (variable reverse repo rate) auctions in bigger amounts. It also plans

to hold 28-day VRRR auctions in addition to the 14-day VRRR to soak up liquidity for longer periods. The overnight surplus, currently at Rs 4-4.5 lakh crore, is expected to fall to Rs 2-3 lakh crore by December, a good enough level to support growth.

While it might seem like RBI wants to keep rates from moving up, the fact is the benchmark yield rose to 6.316% on Friday, after the cut-off for the variable repo rate auction came in at a high 3.99%. The central bank, it would appear, is not averse to higher rates; so, we could see the yield moving up. However, it is unlikely it would be allowed to rise beyond a certain comfort level; if it does, RBI can be expected to step in with more OMOs and OTs. A higher rate at the longer end will, no doubt, push up corporate bond yields but it could see some money being pulled out of riskier assets. As for raising rates at the shorter end of the curve, it makes sense to wait for credit growth to pick up; loan growth has been languishing at some 6% for a long time now.

While retail inflation is expected to remain well within 6% over the next few months, thanks to a helpful base and a moderation in prices of food, inflationary pressures could build up. Despite the sharp spike in prices of crude oil and the fact that core inflation has stayed sticky at 5% plus for 18 months now, the central bank has pruned its inflation forecast from 5.7% to 5.3% for FY22. It is possible the pass-through of higher input costs by companies, as also better demand, could also stoke inflationary pressures. However, it is right to prioritise growth for the moment.

One was expecting some commentary from the Governor on how capital flows are expected to behave later in the year once the US Fed stops bond purchases. To be sure, given the robust exports, strong FDI flows and forex reserves of $640 billion, the external sector isn’t under any kind of pressure. But it would have been useful to know RBI’s assessment on whether there will be large capital outflows from EMs. It is possible RBI doesn’t want to create any sort of panic amidst the global chaos of energy shortages and soaring crude oil prices. One can rest assured the central bank is ready to deal with any exigencies.