A monetary policy that strikes a chord with fisc

In India, it is customary for the RBI to lend support to the Central Government’s fiscal stance and other major economic and financial announcements made in the Budget in its post-budget meetings.  It was no different this time around, with the MPC confirming the prolongation of the current accommodative stance into the next fiscal year and the Governor making a commitment in his statement that the RBI will ‘ensure the availability of ample liquidity in the system and thereby foster congenial financial conditions for the recovery to gain traction.  Some commentators now see a role reversal for the RBI in the sense that unlike in 2020-21 when most of the heavy-lifting to support the badly-battered economy was being done by the RBI, in 2021-22 the fisc will occupy the centre stage from now onwards, with a focus on implementing the slew of spending and structural measures announced in the Budget. And the RBI will stand ready to lend support in every possible way.     

The government is now expected to do the heavy lifting to revive the economy with the RBI playing a supportive role

The decision of the MPC to keep the policy repo rate on hold at 4% was universally anticipated. There was some lurking anxiety on the issue of liquidity guidance, though: in the wake of the notification for the conduct of the 14-day term reverse repo by the RBI on January 11, through which it absorbed liquidity to the tune of ₹ 2 trillion four days later, an impression gained ground that the central bank wanted a calibrated exit from its ultra-loose liquidity policy. This has been dispelled now in the Governor’s statement. And the RBI must be pleased that the actual overnight and other short-term interest rates are now closer to the reverse repo rate (3.35%) than before the notification, as above. Post the policy, the government securities market did not move much vis-à-vis their level seen after the Budget, which fact can be interpreted to mean that right now there are no significant concerns about the Central Government’s borrowing programme for the first half of 2021-22, during which the credit growth is unlikely to accelerate much.   

Inflation-growth projections

With inflation behaving better than expected, thanks to the significant easing of food inflation, the MPC has lowered its projection for CPI inflation for Q4:2020-21 to 5.2 per cent from 5.8 per cent made in its last meeting held in December, 2020. The projections for H1:2021-22 have been kept more or less unchanged, with a caveat that the situation could be different if there is a broad-based escalation in cost-push pressures in services and manufacturing prices and the normalisation of demand happens. Inflation forecasts are largely adaptive, both of individuals and of central banks.

The real growth forecast 2021-22 has been kept a tad lower at 10.5 per cent than in the Budget at 11 per cent. The RBI appears to share the same view as the government that the large revenue and capital spending by the latter in 2021-22 will foster fresh private sector investments which may engender much higher credit growth either concurrently or with a time lag. This is perhaps one more reason why the RBI has provided an elaborate liquidity guidance this time.           

RBI’s market operations

The RBI deserves credit for maintaining stability in the domestic money, forex and government securities market since the onset of the pandemic, including by way of interventions and liquidity operations. This contributed, at least at the margin, in attracting FPI to the tune of US$ 30 billion in the current fiscal year so far.  Not much information is in the public domain about how exactly the RBI ensures consistency of its interventions in money, government securities and forex markets in order to achieve a set of intended policy outcomes, if any. However, it appears that the broad composition of the RBI’s assets, in terms of the relative sizes of its forex and major domestic assets have remained more or less the same since the beginning of 2019-20, despite heavy interventions:

Table

(Unit: ₹ billion)

  [Source: www.rbi.org.in]                                                                                                                                         

This is important, as a sudden and sharp change in the structural division between forex and domestic assets could have implications for the rupee, long-term inflation outlook and the RBI’s exposures to risk. That said, the exact considerations guiding the RBI’s interventions in the forex market, especially its large outright buying of forward US dollar, which have pushed the forward premia higher, are not clear. The net forward buying position of the RBI on end-November, 2020 was higher by US$ 38.50 billion vis-à-vis April, 2020. It is possible that the RBI wants to prevent the rupee from appreciating, both in nominal and real terms and also to stagger over an extended period of time the rupee liquidity creation accompanying US dollar purchases.  But this strategy involves a cost, as the accumulation of large long-term forward positions is inherently risky. In 2019-20, the valuation of outstanding forward contracts resulted in an unrealised loss of ₹ 59.25 billion to the RBI. The loss in 2020-21 could be much higher.

Regulatory measures

Among the regulatory measures, the roll-back of the 100-basis point cut in CRR, which was brought about in 2020 to counter the effect of the pandemic, in two equal instalments, one each in March and May, 2021 is significant. This is in line with the thinking behind the introduction of the 14-day reverse repo. Another noteworthy measure is to allow banks to use TLTRO-on-tap to lend to NBFCs for expansion of credit by them to certain specified stressed sectors. This will help the strong NBFCs to re-establish and even expand the reach in those areas and to those borrowers that are presently not covered by banks.      

Mr. S.S. Tarapore, by far the most brilliant and celebrated former deputy governor of the RBI once famously remarked that while central bankers are expected to be modest, central banking is not.  In the case of the RBI, it has long assumed the task of controlling interest rates of all tenors, in addition to its main responsibility for varying the policy rates, as needed.  Different expressions have been used from time to time, incorporating even unproven propositions, to justify the interventions undertaken to accomplish this task, considered onerous by all major central banks. This time, maintenance by the RBI, of ‘the orderly evolution of the yield curve’ has been ‘explicitly regarded as public goods as the benefits accrue to all stakeholders’, even as it is clear to everyone that use of the term ‘stakeholders’ is a euphemism for the government.

(The writer is a former central banker and consultant to the IMF)