MUMBAI: Reserve Bank of India (RBI) governor Shaktikanta Das is widely expected to announce a status quo in his statement on Friday after the monetary policy committee (MPC) meeting. However, the market is keenly awaiting the RBI’s road map for normalising liquidity in the wake of the government’s oversized borrowing programme, which has pushed up bond yields.
“The notable decline in retail inflation in December 2020 does provide the RBI headroom to ease monetary policy going forward. However, we do not expect a policy rate cut at the forthcoming monetary policy owing to the concerns around core inflation coupled with widening fiscal deficit and normalisation of economic activities, which could weigh on the inflation outlook,” said Care Ratings chief economist Madan Sabnavis. “We expect the accommodative monetary policy to continue,” he added.
The RBI had last month said that it had entered the phase of normalising liquidity. The use of this term was seen as a signal that the central bank would be draining out the surplus funds that it had flooded the markets amid the pandemic.
Many in the markets see this liquidity normalisation like the US Federal Reserve’s comments in 2013 that it was “tapering” off its monetary easing. Those comments led to extreme volatility in money markets worldwide, pushing up bond yields and crashing emerging market currencies.
The policy has to be growth-supportive as the economy is in a recession, having shrunk for two successive quarters. Das has a tough job of ensuring that the policy supports growth without fuelling inflation at a time when the fiscal deficit is expected to hit 9.5%. He has to ensure that the government borrowing does not crowd out private investments and that bond yields remain low despite an oversupply of government paper.
A new challenge is managing the oversupply of dollars as any purchase of the greenback would result in an equivalent release of rupees, which goes against its objective of normalising liquidity. According to a note by Bank of America Securities, the RBI is expected to balance these objectives by allowing banks to hold more bonds without marking them to market, combining bond purchases with long-term reverse repos (where the RBI borrows money from banks) and buying foreign currency in the forward markets, which will help turn sentiment without affecting the liquidity.
“On the liquidity management front, we maintain that the policy intent was to tackle the liquidity asymmetry than to tighten its state, and to fix misplaced risk bets in money markets. Thus, the (mis)communication loop between the central bank and markets needs to be broken,” said Madhavi Arora of Emkay Global in a report.