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RBI Is Right In Taking Cautious Approach With Its Monetary Policies: Economists

The economists are of the thought that inflation can stay sticky and there could be a few dangers to the higher side, given the current rise in product costs.

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The Reserve Bank of India (RBI) is steadily moving forward to ease out the unprecedented steps it has taken since last year to restrict the damage to the Indian economy from the ongoing COVID-19  pandemic. The Monetary Policy Committee (MPC) recently decided to keep the benchmark interest rate unchanged at 4 per cent, however, maintained an accommodative stance. 

The MPC led by Shaktikanta Das, RBI Governor maintained the status quo, the eighth time in a row, meanwhile, benchmark repurchase (repo) rate at 4 per cent. Das stated that MPC unanimously voted to keep the interest rate unchanged and move forward to continue with its accommodative stance as long as it is required to support growth and keep inflation within the target.

However, one question stands which is whether the central bank is correct in its approach or not. 

"Central banks around the world are balancing the growth and inflation dynamics. RBI is right in taking a cautious approach though it would be appropriate to start winding up some of the excesses with regards to liquidity. While growth is recovering, the size of the economy is well below the non-Covid trend. A calibrated approach which encompasses gradual withdrawal of liquidity and hike in reverse repo rate remains the best option to tackle the risks at least in the near term," said Senior Economist at Kotak Institutional Equities, Suvodeep Rakshit. 

To withdraw the measures it took to restrict the financial crisis in 2008, the central bank also took a similar approach at that time.

"There is possibly no other way but to approach the normalisation of monetary policy with baby steps. The Indian economy is on the path to recovery, but this remains uneven. Some MPC members do believe that the data lags in the system have led to a limited understanding of the divergence in stress across the economy. Further, the continuation of some of the measures that are targeted towards alleviating the pain of the small and medium segment continues, another indication that certain sectors may still be seeing stress even as the headline economic indicators improve," said Chief Economist at YES Bank, Indranil Pan. 

According to the Pan, the world over, while policy reversal is being talked of, no central bank is intending to rock the boat. In India, any aggressive steps at policy unwind can risk an increase in the borrowing costs and a derailment of the economic momentum. "Furthermore, uncertainties of global growth, high commodity prices and the associated risks of a pass-through to retail inflation could pose a problem for the ongoing demand-side recovery," said Pan.

The economists are of the thought that inflation can stay sticky and there could be a few dangers to the higher side, given the current rise in product costs. The central bank can prioritise growth over inflation while keeping a close watch on any indication of demand-led inflation. In the month of August, the retail inflation is recorded at 5.3 per cent, as per RBI.

"In my opinion, under the flexible inflation targeting framework, the RBI is no longer looking at anchoring the inflation at 4 per cent but would be happy to see inflation within the upper threshold level of 6 per cent. In our view, as also is the RBI’s, inflation is likely to stay within the tolerance band for the remaining part of the current financial year, thereby providing scope for the monetary policy to stay accommodative and address the negative output gap, which is wider than it was in 2019-20. Further providing comfort is the fact that the 3-month and 1-year ahead median inflation expectations of urban households fell by 50 bps and 60 bps respectively in the September 2021 round of the RBI survey. RBI also sees the inflation emanating from a narrow group of goods: items constituting around 20 per cent of the CPI is responsible for more than 50 per cent of inflation," said Pan. 

G-Sec Acquisition Programme and future:

RBI has already announced that it is ending its G-Sec Acquisition Programme (G-SAP) via which it collected nearly 2 trillion worth of durable liquidity in the initial six months of the fiscal year (FY) 2022.

There was surely a need to moderate the extremely large liquidity surplus in the system. The need for G-SAPs now is also lower as tax collections show an improving trend. With the abatement of the spread of the virus, the further need for the government to spend on supporting livelihood could be lower, Pan mentioned.

"Overall, there is a growing comfort that the fiscal outcome for FY22 is unlikely to be worse than budgeted, effectively reducing the risk of additional borrowings by the Central Government. We need to understand that the calendarized G-SAPs earlier being used as an instrument to clear the government securities supplies, therefore also effectively preventing an upsurge in long-term yields. Current trends indicate a surge in the US yields, and thus EME yields also need to be allowed to go higher to pull in capital and keep the currency market volatility in check," said Pan. 

The Yes Bank economist (Pan) believed that there is no need for an advance calendar from the RBI to support the borrowing programme of the government. Hence doing away with the G-SAP made sense while the RBI retains the flexibility to intervene in the G-sec market through other instruments such as OMO and Operations Twist. 

"GSAP is a yield management tool. With durable liquidity remaining so high, the utility of the GSAP is limited. Also, it is a signal that the RBI is comfortable to let the rates adjust according to market expectations. Markets have been pricing in higher rates over the past few weeks," said Rakshit. 

The possible risks:

Pan also talked about how the world economy is witnessing volatilities due to the uncertainties of the spread of the virus and likely advent of newer strains. Global risks have recently started to increase with indications that the momentum of global growth is slowing, especially in the Western developed economies. 

"Uncertainties also abound with respect to the surge in commodity prices, which could have a negative implication on production costs, retail inflation etc. and can have a detrimental impact on the demand recovery. With a sense now that the higher inflation could stay longer and into 2022, there can be missteps by central banks across the world to tighten earlier and lead to growth slumping again. Between growth and inflation, the bigger risk facing the RBI is inflation, especially as supply shortages and high global commodity prices rule," Pan added.

Rakshit also talked about the possible risk that can come in front of RBI, as far as these assessments are concerned. Inflation will be the biggest risk globally and domestically. Even for RBI, sustained inflationary pressures will require faster than expected interest rate normalization. Sustained inflation and higher rates will have an adverse impact on most asset classes and will result in a risk-off scenario.


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