RBI Likes Glide Paths, Not Crash Landings, Says Deputy Governor Michael Patra

India’s Monetary Policy Committee and its central bank will prefer to wind down the extraordinary accommodation put in place during the Covid crisis over a period of time, while aiming to bring down inflation towards the target of 4% by 2023-24, said RBI Deputy Governor Michael Patra.

"We don’t like tantrums; we like tepid and transparent transitions — glide paths rather than crash landings," Patra said at an event organised by the Confederation of Indian Industry today.

Patra, a member of the MPC and deputy governor in-charge of monetary policy, chose to focus on the flexibility built into India's inflation mandate. He also highlighted benefits derived from the asymmetric cut in two ends of the policy rate corridor — the repo and reverse repo rates — which has drawn criticism. The sharper cut in the reverse repo rate allowed corporates and the government to raise record amount of funds at reasonable rates, Patra said.

The repo rate, the key policy rate, is controlled by the MPC, while the reverse repo rate is under the RBI's purview. In normal times, the reverse repo rate moves mechanistically with the repo rates, however, during the Covid crisis, the RBI chose to break-away from that norm.

"Monetary policy is all about the feasible. This inherently imposes a trade-off with the desirable," said Patra, a career central banker.

Focus On The 'F' Of FIT

Amid questions over whether the central bank is behind the curve on its inflation mandate, Patra drove home the flexibility built into India's flexible inflation targeting regime.

“The essence of FIT is to protect growth by minimising the sacrifice of output which is the ‘price’ of price stability,” he said, highlighting five features of the framework.

These include:

• A dual mandate — “price stability, keeping in mind the objective of growth”.

• An inflation target defined in averages rather than as a point.

• Achievement of the target over a period of time rather than continuously.

• A reasonably wide tolerance band around the target to accommodate, among other things, black swan events like the pandemic.

• Failure being defined as three consecutive quarters of deviation of inflation from the tolerance band, rather than every deviation from the target.

Reverse Repo Rate Debate

Patra defended the RBI's independent setting of the reverse repo rate, which some argue undermines the MPC.

According to him:

• The credit channel of transmission had broken down because of muted demand and risk aversion.

• As such, the RBI decided to operate through other segments of the financial markets.

• After a cumulative 250-basis-point cut, the repo rate was constrained by elevated inflation.

According to Patra, the suggestion of an asymmetric cut in the reverse repo rate had come from an external MPC member. He also signaled that the central bank would return to a normal policy corridor over time.

"Currently, however, the need to revive and sustain growth on a durable basis and mitigate the impact of the pandemic while keeping inflation within the target going forward warrants monetary policy accommodation mirrored in ample liquidity flushed through the system and easy financial conditions," he added.

VRRR Not A Signal Of Normalisation

While the RBI has not taken any steps towards normalisation of policy yet, it started conducting variable reverse repo rate auctions, in order to manage the cost of liquidity. A large surplus of over Rs 9 lakh crore had pushed down short-term rates to below even the reverse repo rate of 3.35%, rendering monetary policy ineffective.

Some market participants saw that as an early sign of normalisation. Patra countered this view.

He said the RBI would remain in surplus mode and the liquidity management framework will continue in absorption mode till credit flow from banks recovers. "This is the natural and the RBI-preferred manner in which surpluses in the liquidity adjustment facility can be reduced."

On Growth And Inflation

Commenting on growth and inflation, Patra said:

• The output gap — which measures the deviation of the level of GDP from its trend — is negative and wider than it was in 2019-20.

• The projection of GDP growth of 9.5% for the year as a whole appears to be on track.

• Inflationary pressures are largely driven by supply shocks. Although shocks of this type are typically transitory, the repetitive incidence of shocks is giving inflation a persistent character.

• Analysis of inflation dynamics indicates that the easing of headline inflation from current levels is likely to be grudging and uneven.

• Pass-through of imported price pressures to retail prices remains incomplete.

• Rising staff costs suggest that incipient wage pressures are building in the organized sector as workplaces fill up.

While the MPC remains committed to the numerical target of 4 (+/-2)%, it is pragmatic to envisage a glide path towards that target, keeping in mind the inherent output costs of disinflation, Patra said.