RBI stays pat on rates, allows liquidity glut to persist for now

In a policy announcement that was a near-replica of the October policy meeting, the Reserve Bank of India (RBI) on Friday left the key rates unchanged and held on to its accommodative stance. The monetary policy committee (MPC) committed to keeping the stance accommodative for as long as necessary and at least during the current financial year and into the next financial year. What confounded the markets was the absence of any measure to suck out excess liquidity at a time when some companies are able to borrow below the reverse repo rate.

The MPC projected consumer price index (CPI) inflation at 6.8% for Q3FY21, 5.8% for Q4FY21, and 4.6-5.2% in H1FY22, with risks broadly balanced. The committee observed that the outlook for inflation has turned adverse relative to expectations in the last two months on account of large margins being charged to the consumer and a pick-up in crude oil prices. “Cost-push pressures continue to impinge on core inflation, which has remained sticky and could firm up as economic activity normalises and demand picks up,” it said in its statement.

The committee expects the recovery in rural demand to strengthen further while urban demand also gains momentum. Taking into consideration a likely spike in Covid infections in parts of the country, business and consumer expectations, fiscal stimulus, the likely advent of a vaccine and the prospects for private investment and exports, the MPC projected real gross domestic product (GDP) growth at (-)7.5% in FY21. The growth forecast for Q3FY21 stands at 0.1% and that for Q4FY21 at 0.7%. It could bounce back to 6.5%-21.9% in H1FY22, with risks broadly balanced.

Some sections of the market had been expecting measures to reduce the surplus liquidity in the system as it might end up contributing to inflationary pressures. However, the RBI said the level of liquidity is tied to the stance of th monetary policy. It stuck to its view that inflation is predominantly attributable to supply-side constraints.

Michael D Patra, deputy governor, RBI, said: “At the current time, our assessment is that a large part of inflation is arising out of supply-side disruptions at the level of the retailer, very high margins being charged by retailers and some amount of indirect taxes. The element of demand, which you could call mischief, is still muted.”

Experts were unconvinced by this explanation at a time the MPC is failing to meet the inflation target month after month. Abheek Barua, chief economist, HDFC Bank, said, “…the absence of any major liquidity absorption measures in the midst of a prolonged inflationary episode and indeed the upward revision of both the RBI’s growth and inflation forecasts might be somewhat puzzling.” He went on to add that this could mean the RBI is still cautious about the durability of growth, given the uncertainties related to it, apart from seeing inflation as principally a supply side-problem. It could also mean that the central bank is willing to tolerate higher inflation as long as growth impulses become firmly entrenched or that it expects some natural moderation in liquidity as the government goes into collection mode in the last quarter of the fiscal. “In fact, given its emphasis on growth revival and the suggestion that there is still some more space left for monetary support, another 25-50 basis point (bps) cut in H1CY2021 cannot be ruled out,” Barua said.

In fact, analysts are now clear that the RBI’s accommodative stance on monetary policy can well be extended to its liquidity policy. Rahul Bajoria and Shreya Sodhani of Barclays Capital said the preference for continued foreign exchange intervention, reserve building and flush liquidity conditions are ultimately tied to reviving growth. “We think the RBI may choose to maintain this position until it sees the drivers of growth become broad based. We also think inflation is a secondary concern in the RBI’s view, given weak aggregate demand conditions,” they said in a post-policy note.

At the same time, the possibility of a partial reduction in liquidity remains. A senior economist FE spoke to said, “Surplus liquidity of Rs 7 lakh crore is excess, but so is surplus liquidity of Rs 3-4 lakh crore. Whether they take it from the former level to the latter is something to be watched.”