India breaking ranks with peers on unwinding easy monetary policy

By Subhadip Sircar

The Reserve Bank of India will likely go slow on normalising its monetary policy settings, breaking step with hawkish global peers to ensure a durable recovery, according to economists.

Policy makers will stick to their resolve of keeping their stance easy to achieve the growth goal for now, said economists, including Standard Chartered Plc’s Anubhuti Sahay. They will instead focus on the tricky task of sponging away liquidity, leaving just enough to keep the economy ticking without adding to inflationary pressures.

RBI Governor Shaktikanta Das, who last year called for coordinated policy response to the pandemic, this month cited risks from Omicron for continuing support to the economy despite calls from a colleague for abandoning the accommodative bias. India’s stance is at variance with the hawkish turn at key global central banks from the US Federal Reserve to the Bank of England as they battle inflationary concerns.

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“Relative to other central banks, it might seem RBI has neither started hiking nor talking about the possibility of rate increases,” said Sahay, head of South Asia research at Standard Chartered. “We need to consider that such countries did not have strict lockdowns like India or have much higher inflation relative to their historical trend.”

Michael Debabrata Patra, RBI deputy governor and monetary policy committee member, recently cited a flattening Phillips curve -- a theory that plots the relationship between jobs and wages -- to conclude that demand conditions were weak enough to keep policy easy for sometime.

That’s “providing some maneuvering room for monetary policy to support the recovery without being hemmed in by demand-driven inflation concerns,” Patra said, referring to the curve which tends to steepen when employment rises, pushing wages higher and stoking demand-led inflation.

Although the RBI kept its growth projection unchanged at 9.5 per centfor the current fiscal year ending March, it is forecasting a slower expansion of 7.8 per cent next year. It sees inflation peaking in the January-March period before stabilizing in the next two quarters at 5 per cent-- within its 2 per cent-6 per centtarget band -- allowing it room to support growth.

Besides, a huge buffer of nearly $650 billion in foreign exchange reserves, gives policy makers the space to insulate an emerging economy like India from the volatility that comes with almost every Fed tightening cycle.

‘Elephant in Room’

Nevertheless, the central bank has been keen to address the huge liquidity overhang in the banking system, which HSBC Holdings Inc. recently described as the “elephant in the room.” Liquidity is likely to remain elevated around the Rs 6 lakh crore ($80 billion) mark over fiscal 2023 and 2024, according to projections by the bank, down from around Rs 10 lakh crore earlier this month.

On its part to rebalance the liquidity in the system, the RBI is migrating the excess cash that banks park with it from the fixed-rate reverse repo to the auction-based variable rates, over which it has better control. Latest data show that banks parked Rs 95,400 crore with RBI at the fixed rate of 3.35 per centon Monday, with the central bank planning to migrate most of its liquidity absorption to an auction-based mechanism from January.

As part of that migration, the RBI will aim to mop up Rs 7.5 lakh crore via 14-day reverse repo on December 31. It shocked markets last week by introducing a shorter 3-day variable reverse repo, further pushing up short-end rates.

The move to apportion more liquidity to VRRR auction could be seen as a precursor to a hike in the reverse repo rate in February, with the key policy rate likely on hold until the third quarter of 2022, according to Bloomberg Economics’s Abhishek Gupta.

“Higher money market rates and an expected hike in the reverse repo rate ahead should be seen as a function of liquidity trending down from the current record surplus, rather than a move by the central bank to tighten policy,” he wrote in a note.

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