The Reserve Bank of India's monetary policy committee (RBI MPC) struck a surprisingly dovish chord yet again in this policy, choosing to keep all the key rates unchanged, including the Reverse Repo Rate.
The Repo-Reverse Repo policy corridor had widened since the onset of the pandemic, from the conventional 25 bps to 65 bps, as the RBI gave the much-needed liquidity boost in 2020 to manage financial stability during the pandemic. There was a wide consensus among market participants this time, that given the ongoing liquidity normalization by the RBI, it would hike the reverse repo rate by a modest 15 bps to perhaps even 25 bps. However, the RBI has chosen to stay on the sidelines for now, citing downside risks to the economy from the Omicron wave and therefore focusing more on ensuring a strong and sustainable economic recovery rather than fighting the current inflationary trends.
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On the inflation front, the RBI finds the current high prints of CPI inflation to be more on account of unfavourable base effects rather than any structural trend, and expects the CPI to moderate in the second half of FY 2022-23. What is noticeable is that the RBI, at this point in time, does not seem to be too concerned about the persistent high global oil prices (although it views this as a risk) and is also somewhat disregarding the widespread global concerns around inflation and the consequent rise in global interest rates, with central bankers of developed nations already tightening their belts and starting to raise policy rates.
In the policy statement, the MPC was silent on how the central bank proposes to manage the enhanced government borrowing programme that is going to kick in, starting April, pursuant to the expansionary Union Budget announced earlier this month. Debt markets will be wary about the increased supply in the new financial year, and will want clarity around the extent to which the RBI will support the borrowing through OMOs, G-SAPs, Operation Twist, etc. The RBI has probably put off this discussion for the April policy.
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On the liquidity front, the RBI is satisfied that the liquidity injection measures undertaken by it over the past couple of years have achieved the desired objective of maintaining financial stability through the pandemic. While the RBI has already undertaken the Variable Rate Reverse Repo (VRRR) auctions to suck out excess liquidity from the money markets, it is now looking to rebalance liquidity on a dynamic basis. While on the one hand the accommodative stance continues (for now), on the other hand, given the ongoing liquidity surplus (though lower than in 2021), the RBI proposes to restore the pre-pandemic liquidity management framework. Towards this, it will use variable rate repos (VRRs) and variable rate reverse repos (VRRRs) of 14 days as the main liquidity management tools, with intermittent fine-tuning, and limiting the use of the fixed-rate reverse repo and MSF windows. Given this shift, the overnight rates are likely to settle somewhere near the repo rate.
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To summarise, the RBI is possibly buying some time before it decides about moving out of its accommodative stance and graduating towards a more directional change in interest rates. The debt markets have reacted positively to the pause in this policy; however, the celebration could be short-lived. The key ponderables in the near-term for the markets would be (a) how the RBI will manage the escalated borrowing in the next year and maintain an orderly yield curve, and (b) the global inflation trends and the Fed aggressive posture on the one hand and a soft and accommodative RBI on the other hand, and the likely impact on foreign debt flows as well as the Rupee. The enhancement of the Voluntary Retention Route limits may give some relief to the g-sec markets, in absence of any firm guidance on inclusion of Indian debt securities in the global bond indices.
The debt markets were actually prepared for a reverse repo rate hike in this policy, and it was possibly an opportune time to do the “shift”. So was this a missed opportunity?