RBI’s Sophisticated Balancing Act With Newer Experiments
We are seeing a sophisticated deployment of innovative instruments to manage multiple objectives in face of economic uncertainty.
The Monetary Policy Committee, as widely expected, kept the policy repo rate on hold. An accommodative stance was also unanimously maintained. Yet, overlaid on this status quo, there is a significant expansion of the use of innovative instruments and approaches. This is being done to manage the expanding envelope of uncertainty due to rising Covid-19 cases as well as risks of spillovers from external developments. The recurring motif of the policy was “action, communication, and signals”. This article focuses on a few of those, from the many embedded in the liquidity management framework planned for FY22.
The recent surge in coronavirus cases had already tempered and extended the timelines for the normalisation steps that were widely expected prior to the surge. The language of the MPC and the RBI governor’s statements and forward guidance related to the stance is of marked interest in the context of the high levels of uncertainty – together with market concerns of the effects of the large borrowing programme of central and state governments in FY22.
To put in succinctly, the operating mechanisms have tried to strike a fine balance between a degree of predictability in the forward guidance and retaining discretion for RBI to respond to evolving conditions.
Before elaborating on these, a look at the signals from the RBI’s macroeconomic forecasts.
FY22 real GDP growth projections were unchanged from the February meeting’s 10.5%, which was expected given the heightened uncertainty on duration, intensity, and coverage of the lockdowns. Inflation projections were nudged up from the earlier 5.0-5.2% in H1 and 4.3% in Q3, to 5.2% and 4.4% respectively, implying an average of 4.98% in FY22 (versus 6.2% expected for FY21).
Even before the recent surge in Covid cases, there had been signs in January and February, flowing into the first couple of weeks in March, of a slowdown and even a reversal in the economic momentum.
The set of high-frequency ‘nowcaster’ data we track at Axis Bank actually suggests that the Composite Leading Indicator of economic activity rose almost 10% in March over February.
This was led by sharp increases in GST collections, E-Way bills, FasTag payments, and other indicators of freight movement, as well as external trade numbers.
Based on this, the following are our qualitative thoughts on the operating plans envisaged by RBI for FY22.
Change In Language
First, in a change of approach, there was an ostensible shift in the forward guidance from “time-dependent” to “state-dependent” for transitioning from accommodative to gradual calibrated normalisation. The MPC voted “to continue with the accommodative stance as long as necessary to 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”.
Missing from this was the caveat “ … into the next financial year (i.e., FY22)” in the February policy. As a side note, a point to our general readers is that “state-dependent” is just a fancy word that economists use for what all of us understand as “data dependent”, augmented with forecasting and statistical techniques.
A New Backstop
Second, was an introduction of a new instrument, the G-Sec Acquisition Programme or G-SAP 1.0. This is one more addition to the toolkit for managing interest rates along the yield curve, which have included Open Market Operations in both central and state government bonds (G-Secs and SDLs), Operation Twist, and multiple regulatory forbearance measures like liberal Hold-to-Maturity limits, etc.
The G-SAP is akin to calendared OMOs, but not quite. Calendars have definite dates, the G-SAP does not.
It is just an assurance by RBI that central government bond investors will have a backstop of Rs 1 lakh crore of ‘assured’ RBI purchases of G-Secs over the course of Q1FY22, incorporating quantitative easing like elements. In addition, the prospects of expansion of this programme into the next quarters have been kept open. The G-SAP is a very nice balance between elements of assurance and surprise, which a central bank needs to manage the interplay with markets to manage “an orderly evolution of the yield curve”.
A corollary of measures to maintain orderly financial market conditions is the ability to manage the immediate consequence: system liquidity. While assuring ample liquidity and orderly market conditions, RBI will face a challenge in managing liquidity over FY22. Measures to encourage the adoption of digital banking will reduce cash leakage from the system, which has helped to absorb some of the excess liquidity in FY21. While longer-maturity Variable Rate Reverse Repo auctions will help, many more instruments to absorb the expected surplus will need to be deployed.
Yes, there are multiple risks, which are likely to harden over the course of 2021.
In India, a demand recovery following prospects of continued higher government spending by both the centre as well as states in FY22 also adds to risks of adding to inflationary pressures, although the spending is necessary to support growth. Supply dislocations will add to near-term pressures. A synchronised global recovery later in 2021 due to vaccination rollouts and consumer confidence is expected to add to the effects of an already elevated set of global prices – agro commodities, industrial metals, and crude. And once again came the reiteration of RBI continuing “to do whatever it takes to preserve financial stability and to insulate domestic financial markets from global spillovers and the consequent volatility”.
Adapting To The Unknown
RBI has shown remarkable audacity and risk appetite in countering this once-in-a-century economic shock, having responded since late March 2020 post the onset of disruptions following public health measures to contain the pandemic. It has experimented with multiple first-in-class measures, yet calibrated with appropriate risk mitigating guardrails, often emphasising an approach of “crossing the river by feeling the stones”, in an environment where there is no playbook to learn from. Many operational details still require clarification, but these will be forthcoming in the next few days. Wednesday’s policy measures are a significant advance on these experiments, melding forward guidance with discretion.
Saugata Bhattacharya is Executive Vice President and Chief Economist at Axis Bank. Views are personal.
The views expressed here are those of the author, and do not necessarily represent the views of BloombergQuint or its editorial team.