PremiumThe Reserve Bank of India (RBI) has embarked on the long-awaited normalization process of monetary policy, even while announcing a status quo on the policy repo rate (four percent) and on the stance (accommodative). In addition, governor Shaktikanta Das declared a change in the RBI’s priorities: From the earlier mode of putting ‘growth before inflation’ the RBI would henceforth sequence ‘inflation before growth’.
He did not use the word ‘normalization’. But the impact of the new Standing Deposit Facility at which banks could park their surplus funds (without collateral) with the central bank at 3.75%, as against the reverse repo rate of 3.35%, while positioning the Marginal Standing Facility (MSF) at 4.25% as the upper end of the new Liquidity Adjustment Facility (LAF) corridor, marks the beginning of the ‘normalization’ process. This is because the width of the LAF now stands reduced to its pre-covid level of 50 basis points (down from 65 basis points), signalling a return, albeit slowly, to the pre- covid scenario.
One could argue, of course, that the reduction in the LAF corridor, as well as the more nuanced statement from Governor Das are baby steps, given the dramatic shift in the RBI’s projections for the growth vs inflation trade-off. The growth projection is down from 7.8% to 7.2% now, while the inflation projection is up from 4.5% to 5.7%.
The MPC’s statement this time is far more guarded in contrast to the one in February 2022: “The MPC also decided unanimously to remain accommodative while focussing on withdrawal of accommodation (emphasis added) to ensure that inflation remains within the target going forward, while supporting growth". Then there was no mention of “withdrawal of accommodation". On the contrary, then the RBI’s position was that “forward guidance of accommodative stance" would be maintained “as long as necessary to revive and sustain growth on a durable basis and continue to mitigate the impact of covid-19 on the economy, while ensuring that inflation remains within the target going forward".
In the gobbledygook world of central bank speak, many may even see this as a significant change from a central bank that has been notoriously loath to change its language over the past many meetings.
Presumably, the tectonic shift in the macroeconomic scenario left the RBI with few options. Remember, risks remain high. The US Fed is expected to announce a much larger increase (50 basis points) in the Fed rate at its upcoming meeting in May than was earlier projected and commence a more aggressive withdrawal of liquidity. At the same time, the continuance of the war in Europe will keep oil and other commodity prices high.
Given the increase in the RBI’s inflation estimates is much larger compared to the reduction in its growth estimates, perhaps, there was really no option but to start the course correction. This is what many observers, including Mint SnapView, had been pointing out all along. The RBI had chosen to ignore this. Till now. The improvement in capacity utilization, from 68.3% to 72.4%, as well as better external sector strength, may have given the RBI courage to effect the much-needed shift in priorities.
Going forward, now that it has recognized the need to correct for its past focus on growth at the cost of higher inflation, the RBI must persevere in its efforts till average (rather than point-to-point) inflation reverts back to the mid-point of its target range – four percent.
Needless to say, as with any course correction, there will be some pain. The yield on risk-free government securities will move up and with that interest rates across the spectrum. Both government (that has an ambitious borrowing target for the first six months of the financial year that started on April 1) and other borrowers will have to pay higher rates of interest, while depositors, who have long had to suffer a negative real rate of interest on their savings, will benefit.
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