Smart RBI created scope within the limited space to keep pushing growth


The first Monetary Policy Committee (MPC) meeting of FY22 took place when the country has been witnessing a fresh surge in the Covid-19 cases. The second wave of the pandemic has created uncertainty for India’s near-term growth prospects. Ever since the advent of the pandemic, RBI has resorted to various liquidity and other measures to support the economy. More than a year into the pandemic, the central bank now has only limited space to announce further monetary stimulus.

Yet, within that limited space, the MPC succeeded in conveying that it will continue with necessary measures to support growth.

  • Thumbs up from the bond market

The decision on interest rate was on the expected line, with the repo rate kept unchanged at 4 per cent. However, the RBI Governor reiterated the central bank’s commitment to ensure ample liquidity in the system. One of the highlights of the MPC meeting was the announcement G-Sec acquisition program 1.0 (G-SAP 1.0), which the bond market needed the most.

Bond yields have been under pressure due to developments in both the domestic and global economies. RBI’s intervention through Open Market Operations (OMOs) has had only limited impact in bringing down bond yields. The surge in bond yields could prove costly to an economy recovering slowly from the pandemic-induced crisis.

Under the newly-announced program, RBI will commit upfront to a specific amount of open market purchases of government securities. OMOs refer to the buying and selling of government securities by RBI to regulate liquidity in the market. In the current scenario, with the purchase of government securities by RBI, the increase in demand will push up the prices. There exists an inverse relationship between bond prices and bond yields — as bond prices increase, bond yields come down. It clearly shows RBI’s commitment to balance the excess supply of government bonds in the market.

Both the government and the corporate sector will benefit from the program. The government’s market borrowing for FY22 is estimated at Rs 12.05 lakh crore. And, with the yields coming down, the government will be able to borrow at a cheaper rate. The same is applicable to the private sector, as G-sec yields are often used as the benchmark for corporate bonds.
In its last MPC meeting, no major measures were announced for the bond market. However, this time the G-sec acquisition program 1.0 came with more clarity and transparency as RBI announced the purchase of Rs 1 lakh crore worth of government securities for Q1FY22.

On the other hand, to absorb surplus liquidity in the system, MPC decided to conduct Variable Rate Reverse Repo (VRRR) auction of long-term maturity. RBI has already started its liquidity normalisation process. For instance, in the last MPC meeting, an announcement was made for the restoration of the cash reserve ratio (CRR) in two phases. However, the Governor has clearly communicated that VRRR should not be viewed as a liquidity tightening step, but a part of the liquidity management operation.

  • Inflation and growth outlook

The RBI Governor pledged to maintain an accommodative stance as long as necessary to sustain growth, but also cautioned about the factors that could push up prices. The high international commodity prices and logistical costs could build up inflationary pressure in the domestic economy.

Similarly, localised lockdown and restrictions could also lead to supply-side disruption putting pressure on prices. On the growth front, RBI expects the economy to grow 10.5 per cent in FY22. However, the achievement of a 10.5 per cent GDP growth would depend largely on how well the country can control the second wave of the pandemic.

  • The road ahead

Overall, RBI took a dovish stance on the monetary policy this time while balancing the inflation-growth scale. Perceived as a positive note, the markets rallied; and the Governor was also successful in giving the bond market a positive signal by emphasising that RBI will ensure that bond yields are in check. Despite such positive signals, RBI should be prepared to deal with a volatile environment, considering the developments in the global economy.

First published in Economic Times.


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