This dovish policy by the RBI came at the right time since concerns about the second wave of the coronavirus outbreak are mounting.
Monetary policy management involves managing many contradictions. Pursuit of growth can be inflationary and focusing on price stability can adversely impact growth. In the modern era of open capital accounts and massive foreign portfolio inflows and outflows, managing exchange rate stability becomes challenging. The challenge becomes all the more daunting when you have an unprecedented pandemic impacting economies severely.
Growth is RBI’s top priority
The Reserve Bank of India deserves appreciation for managing these contradictions in these uncertain times. The central bank’s policy announcement keeping policy rates unchanged—repo and reverse repo at 4 percent and 3.35 percent, respectively—was along expected lines. But markets—both bond and equity—reacted positively because they were enthused by the better-than-expected dovish stance of the central bank. Governor Shakti Kanta Das made the central bank’s priority crystal clear with the message: “Growth is of paramount importance at this juncture.” Since the RBI wanted the bond yields to cool down, Das declared that “the RBI will do whatever it takes for the orderly evolution of the yield curve”.
This declared stance was followed up with the announcement of a new programme called GSAP (Government Securities Acquisition Programme), which will run parallel to the open market operations (OMOs).
GSAP is a sort of quantitative easing. Since the governor has called this GSAP 1.0—the RBI will buy government bonds worth Rs 1 lakh crore in Q1 FY22—it is safe to assume that more will follow. These actions and announcements were enough to enthuse both the bond and equity markets. The 10-year yield dipped below 1.10 percent and Nifty closed with gains of 135 points on April 7.
Second wave a concern but unlikely to dent growth
This dovish policy came at the right time since concerns over the second wave of the coronavirus pandemic were rising. Since the second wave is the worst in economically significant Maharashtra, apprehensions are that this will impact economic activity and GDP growth adversely. Therefore, it is important that the present sharp rebound in growth is sustained with policy support.
It is a fact that the low-interest regime has turned out to be a strong tailwind for segments like housing and automobiles. Sustaining growth in these employment-intensive segments is the need of the hour. This needs the continuation of the low-interest rate regime supported by low bond yields and adequate liquidity. The RBI has ensured this.
However, it is important to appreciate the fact that we are in the midst of profound uncertainty. Globally, inflation is a threat. The combination of ultra-loose monetary policy being followed by the Fed and the massive fiscal stimulus announced by US President Joe Biden have the potential to trigger inflation. At home, even though inflation is under control, core inflation is on the higher side. So, the RBI will have to keep an eagle’s eye on the price level.
For equity investors, it makes sense to remain invested in this bull market. This bull market has been climbing many walls of worries but since uncertainty is profound and valuations are on the higher side, occasional profit-booking is advisable.
First published in moneycontrol.com.