RBI Monetary Policy: The Central Bank Does The Right Thing
Through its decisions and words, the RBI has restored the primacy of its inflation control mandate. It has done the right thing.
It’s been more than two years since the Reserve Bank of India governor and deputy governors last addressed a press conference in person. They returned to one for the April monetary policy review. Everyone kept their masks on and the little plates of dry fruits (the dried figs were our favorites!) were missing. Besides that, the new-normal was as close to the old-normal as possible. Including the bickering for just one more question!
This normalisation came alongside policy normalisation. Having flirted with normalisation for the past few policies, the Indian central bank has finally committed to it.
There are a few decisions and comments that are noteworthy.
First, the change in priorities.
Old-time RBI watchers will remember that the central bank, back in the day before the inflation targeting framework came in, used to list out its relative priorities between growth, inflation and financial stability. With the inflation targeting framework giving the central bank clear goals, this was no longer necessary. Then came the Covid-19 pandemic and the RBI used the flexibility in-built in the inflation targeting framework to shift focus to growth.
But inflation has remained high, now forecast to average 5.7% in year-three of pandemic, even as the initial growth impact of the crisis has waned. For some months now, it has been clear that the RBI needs to bring its focus back to inflation. This was reinforced with the inflationary pressures brought on by the Russia-Ukraine crisis.
At this policy, the Monetary Policy Committee and the RBI finally changed their related priorities.
The committee’s guidance now says that it continues to "remain accommodative while focussing on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth." This is a marked change from the earlier guidance which said that the committee would stay "accommodative stance as long as necessary to revive and sustain growth on a durable basis and continue to mitigate the impact of Covid-19 on the economy, while ensuring that inflation remains within the target going forward."
The central bank is effectively admitting what many have argued — that the role of monetary policy is repairing growth is now largely done and it must switch focus back to inflation.
The only remaining quibble we have is with actual stance of monetary policy.
Could the central bank have moved to a neutral stance rather than staying "accommodative with a focus on withdrawal of accommodation", which sounds contradictory? RBI deputy governor Michael Patra explained this by saying that while they are moving away from an "ultra-accommodative" policy, there is still room to stay "accommodative".
The second important decision has been the restoration of the peace-time liquidity framework, so to speak.
Remember that during the Covid crisis, after the repo rate was cut to 4% which acted as an effective lower bound for rates in India, the RBI used the width of the rate corridor and the reverse repo rate as an independent tool. The reverse repo rate was then cut all the way down to 3.35%.
There were two problems with this. First, the RBI set the reverse repo rate, which reduced the importance of the monetary policy committee in the overall scheme of things. Second, it allowed for greater volatility in short term rates.
Of course, in restoring the width of the corridor, the RBI has moved from the reverse repo window to the standing deposit facility window. This has effectively allowed it to raise the floor on interest rates by 40 basis points from the reverse repo rate of 3.35% to the SDF rate of 3.75%.
That's killing two birds with one stone.
RBI Monetary Policy: Central Bank Activates Standing Deposit Facility To Deal With Surplus Liquidity
A third important change is that RBI has brought the consideration of real interest rates back to the table. The discussion has been absent ever since the Covid crisis hit.
In the post-policy press conference, when asked about real rates, deputy governor Patra said that in a growing emerging economy, real rates should be positive and the "process of moving towards a positive real rate has started."
At present, with one year ahead inflation seen at 5.7% and the policy repo rate at 4%, real rates are negative. But Patra's comment suggests this will slowly change by way of higher repo rates, unless inflation were to come in sharply lower than projected.
Finally, the central bank stayed away from any express commitment to support the bond markets. RBI governor Shaktikanta Das did say that they remain focused on the completion of the government borrowing programme and that all options remain on the table.
When quizzed, Das also said they remain committed to the orderly evolution of the yield curve, but there was nothing beyond that.
Given that liquidity is in large surplus and inflation is rising, committing specific support to keep yields low would not have been the right thing to do.
There is no doubt the central bank's role as a debt manager to the government will weigh heavy on the RBI this year, but it is now mindful that the primacy of its inflation control mandate must be restored. Through all of the measures and words above, the central bank has done just that. And it has done the right thing.
Ira Dugal is Executive Editor at BloombergQuint.