The Monetary Policy Committee of the RBI has been consistently facing the growth vs inflation challenge for past three years at least. However, the conditions have become significantly more challenging and complicated for the MPC in the recent months. Hence, in the past couple days MPC may not have spent much time on resolving the growth vs inflation conundrum.
Since, the issue of adding to monetary stimulus is no longer part of the current agenda, the MPC deliberations might have been pinned around three issues –
1. How to pace the liquidity normalization so that it does not hurt the fragile recovery?
2. When to begin hiking policy rates?
3. How to manage the large government borrowing?
Price stability may certainly have received some attention. But notwithstanding what the prime minister may have claimed in the Parliament, the MPC might have expressed helplessness in controlling the price volatility, especially the prices of essential items like energy, and seasonal fruits & vegetables.
In past couple of meetings, the RBI has made it unambiguous that while MPC continues to maintain its accommodative policy stance to support the growth, RBI shall continue to withdraw excess liquidity from the financial system through variable rate reverse repo auctions (VRRR) and other available means. No change is expected in this stance.
The market consensus believes that a 25-40bps hike in reverse repo rate (presently 3.35%) would be in order to guide the call money and short term rates higher and prepare the markets for an eventual repo hike later in 2022.
Even though the benchmark yields have spiked more than 50bps since last MPC meeting in December 2021; inflation is persisting close to upper bound of RBI tolerance range; and global bond yields have also spiked sharply - no one is expecting a repo hike today.
In the past couple of years, RBI and public sector banks (PSBs) have absorbed a material part of government issuance, since RBI was in the liquidity infusion mode and PSBs were struggling with poor credit offtake and extreme risk aversion. Both these conditions no longer exist. The RBI is in the process of unwinding the excess liquidity and PSBs are gearing for pickup in credit demand. Besides, the RBI has also allowed banks to prepay the outstanding under TLTRO and additional 1% of NDTL allowed under MSF since 2020 has been withdrawn from January 2022.
Arranging to execute a much larger government borrowing program would therefore be a challenge for the RBI, especially when the benchmark yields are already at uncomfortable levels. The RBI may therefore be more concerned about exploring the additional avenues of demand for government securities so that the benchmark yields could be pinned down and less disruptive repo hikes could be planned. As Morgan Stanley highlighted in one of their recent reports, one of the additional sources of demand could be issuance of “Fully Accessible Route (FAR) bonds, leading to India's inclusion in global bond indices. The resultant bid on long bonds could depress yields in addition to easing pressure on banks to fund the fiscal deficit.”
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