Shaktikanta Das, Governor of the Reserve Bank of India, stated that the Monetary Policy Committee has decided to retain key policy rates at current levels in order to revive and sustain growth and continue to mitigate the impact of Covid on the economy.
At the bi-monthly policy meeting on Friday, the MPC voted unanimously to maintain the status quo with regard to the policy rates and by a majority of 5 to 1 to retain the ‘accommodative’ stance so as to ensure adequate liquidity to support economic recovery.
In his policy address, Shaktikanta Das said, “The marginal standing facility (MSF) rate and the repo rate remain unchanged at 4.25% and the reverse repo rate at 3.35%. With the worst of the second wave of Covid behind us and a significant increase in vaccination, the Indian economy is gaining traction.”
Improvement in government capex, together with congenial financial conditions, could bring about an upturn in the much-awaited virtuous investment cycle. The projection for real GDP growth in 2021- 22 is retained at 9.5% and for Q1:2022-23 it is projected at 17.2%. Overall, the CPI headline momentum is moderating, which, combined with favourable base effects in the coming months, could bring about a substantial softening in inflation in the near-term. CPI inflation is projected at 5.3% for 2021-22.
Liquidity, Financial Market Conditions
The level of surplus liquidity in the banking system increased further during September 2021, with absorption under fixed rate reverse repo, variable rate reverse repo (VRRR) of 14 days and fine-tuning operations under the liquidity adjustment facility (LAF) averaging Rs 9 trillion per day as against Rs 7 trillion during June to August 2021. The surplus liquidity rose even further to a daily average of Rs 9.5 trillion so far up to October 6. The potential liquidity overhang amounts to more than Rs 13 trillion. A near-consensus view emerging among market participants and policy makers is that the liquidity conditions emanating from the exceptional measures instituted during the crisis will need to evolve in sync with macroeconomic developments to preserve financial stability. This process has to be gradual, calibrated and non-disruptive, while remaining supportive of the economic recovery.
The total liquidity injected into the system during the first six months of the current financial year through open market operations (OMOs), including G-Sec Acquisition Programme (G-SAP), was Rs 2.37 trillion, as against an injection of Rs 3.1 trillion over the full financial year 2020-21. Given the existing liquidity overhang, the absence of a need for additional borrowing for GST compensation, and the expected expansion of liquidity in the system as government spending increases in line with budget estimates, the need to undertake further G-SAP operations at this juncture does not arise.
Keeping in view the market feedback, it is proposed to undertake the 14-day VRRR auctions on a fortnightly basis: Rs 4 trillion on October 8, Rs 4.5 trillion on October 22, Rs 5 trillion on November 3, Rs 5.5 trillion on November 18 and Rs 6 trillion on December 3. Even with all these operations, the liquidity absorbed under the fixed rate reverse repo will still be around Rs 2-3 trillion in the first week of December 2021. The RBI will ensure that there is adequate liquidity to support the process of economic recovery.
Technology ties us together
Shaktikanta Das further said: “The Reserve Bank has taken more than 100 measures to proactively and decisively respond to the pandemic crisis. We have not hesitated to take new and unconventional measures to keep the financial markets functioning and the market sentiments positive, provide liquidity to targeted sectors and institutions, and leverage on digital technologies to reach out to individuals and businesses. Thus, although the pandemic protocols do us part, technology ties us together.”
Policy seeks to accomplish numerous objectives: Experts
Nilesh Shah, Group President & MD, Kotak Mahindra Asset Management Company, commented on the key policy decisions, saying the RBI’s policy is a ‘Mai Hu Naa’ policy aimed at achieving multiple objectives: supporting growth, keeping inflationary expectations under check, stabilising financial markets, maintaining adequate and appropriate liquidity, retaining a straight yield curve, and ensuring the smooth passage of the government’s borrowing programme. The MPC has assured markets that normalisation of monetary policy will be gradual and calibrated.
“The decision on key rates as well as the voting pattern in today’s monetary policy review was along expected lines,” said Anagha Deodhar, Chief Economist, ICICI Securities. “The MPC revised its inflation projection for FY22 downward to 5.3% (from 5.7% in the August review), owing mostly to lower expected inflation prints in Q2 and Q3. While it retained its 9.5% growth prediction for FY22, it noted that the external environment is becoming more uncertain and challenging. On the regulatory front, the RBI extended the SLTRO for small finance banks till December 2021, decided to continue with the extended WMA limit till March 2022, and extended inclusion of lending to NBFCs in the priority sector till March 2022. Additionally, the RBI discontinued GSAP and announced that it was open to supplement 14-day VRRR with 28-day VRRR.”
According to Rajeev Radhakrishnan, CIO, Fixed Income, SBI Mutual Fund, GSAP auction, as expected, is the first casualty with the RBI not announcing any incremental GSAP. The governor’s statement attempts to soothe markets by not projecting any of these measures as unwinding of accommodation. The measures taken currently do not address a durable absorption of the quantum of surplus liquidity. It is unlikely that the short end rates will directionally move closer to the policy rates. Market direction is expected to be volatile as the overhang of additional measures remains. External factors such as commodity prices and the unwinding of monetary accommodation globally could counterbalance that.
Anil Gupta, Vice President & Sector Head, Financial Sector Ratings, ICRA, said that the scheme has been instrumental in incremental credit flow from banks to NBFCs and in turn for lending to identified sectors. The funding from banks via this route has also been at more competitive rates than normal bank rates, which in turn reduces the cost of borrowing for identified sectors. Extension of the scheme hence remains positive for incremental credit flow, he stated.