Reverse repo status quo needed to give more time for economic recovery to strengthen: Report

Amid the rising scare from the new coronavirus variant Omicron and ahead of the MPC meeting, SBI house economists have urged the central bank to delay liquidity normalisation measures through a reverse repo hike, as such a "prudent step" in the current situation will give more time for economic recovery to strengthen further.

The Reserve Bank of India (RBI) has been sucking out excess liquidity through other measures so far, which has resulted in liquidity surplus massively being brought drastically in the recent months, SBI Research said in a note.

It noted that the use of the reverse repo tool need not be limited to the monetary policy announcement alone.

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In the weekend note, Soumya Kanti Ghosh, chief economic adviser at the State Bank of India Group, said that as the situation is still evolving, a status quo on reverse repo rates may be maintained in the next policy announcement on December 8.

This is keeping in mind that the effective rate has already been pushed up with VRRRs (variable reverse repo repurchases) and the amount and tenor of the same can be fine-tuned for the desired outcome, she added.

System liquidity though remains surplus with the average daily net absorption under the liquidity adjustment facility at Rs 7.6 lakh crore in November, durable liquidity has been declining and now stands at Rs 11.2 lakh crore compared to Rs 12.0 lakh crore at the time of the previous policy. Liquidity surplus has progressively narrowed since RBI stopped liquidity infusion through GSAP operations.

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Also, there has been calibrated progress towards liquidity normalisation since the October policy with the amount parked in overnight fixed reverse repo declining to Rs 2.6 lakh crore from Rs 3.4 lakh crore at pre-October policy.

Moreover, the RBI has largely achieved its objective of pushing up short-term rates with a three-month T-bill rate that was below reverse repo in August, now at 3.52 per cent, factoring in the impact of VRRRs. Similarly, six-month and one-year T-bill rates have moved up by 20-30 bps since October.

Against this background, the report said, "We believe the talks of a reverse repo rate hike on December 8 may be premature as the RBI has been able to narrow the corridor without the noise of rate hikes and ensuing market cacophony.

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"Moreover, Section 45Z (3) of the amended RBI Act of 2016 clearly states that the monetary policy committee shall determine the policy rate required to achieve the inflation target," Ghosh said.

She added that nowhere in the MPC mandate is there any reference to its role in liquidity management, which remains internal to the functioning of the RBI. "Thus, the RBI is not obliged to act on reverse repo rate only in MPC."

Further, change in the reverse repo rate is an unconventional policy tool that the RBI has effectively deployed during the crisis when it moved to a floor instead of the corridor. As the width of the policy corridor acts as an independent instrument for the central bank in a crisis and an asymmetric corridor is a logical outcome under such.

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Moreover, the RBI can "deflate the hype around reverse repo hike in monetary policy by explaining the virtues of using reverse repo change as a pure liquidity tool and not a rating tool", as it can supply any amount of additional liquidity without pushing short-term money market rates below the key policy rate.

Thus, the interest rate can be set to achieve monetary goals, while the amount of liquidity in the banking system can be used to stabilise the financial market, Ghosh said.

She also noted that since the pandemic, the RBI has done exactly this balancing act, and the pandemic is not yet over.

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"Against this background, delaying normalisation measures is prudent in the current situation which would also give time for economic recovery to strengthen further…the stance needs to continue to be accommodative to support growth while the recovery remains uneven.

"Any change instance at this point may disrupt the markets affecting the nascent recovery," Ghosh argued.

Another reason for the status quo is that the latest retail inflation also indicates that the weighted contribution of domestic inflation has been falling since July and imported inflation is rising. Thus, inflation dynamics too don't warrant a change in the present policy stance.

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