RBI likes glidepaths rather than crash landings vis-a-vis lift-off of interest rates or withdrawal of liquidity: Dy Guv Patra

Our Bureau Mumbai | Updated on September 16, 2021

Reiterates that the suggestion to adjust reverse repo rate asymmetrically relative to the repo rate was made by an external member of the MPC

The Reserve Bank of India (RBI) doesn’t like tantrums when it comes to lift-off of interest rates or withdrawal of liquidity, preferring glidepaths rather than crash landings, according to Deputy Governor, Michael Debabrata Patra.

“...We don’t like tantrums; we like tepid and transparent transitions – glidepaths rather than crash landings,” Patra said in his address at the Financial Markets Summit of the Confederation of Indian Industry.

Patra underscored the RBI’s analysis of inflation dynamics indicating that the easing of headline inflation from current levels is likely to be grudging and uneven.

“First, the distribution of inflation has skewed to the right with high variance – a large number of items is massed in a long fat right tail, pulling the mean of the distribution to the right of the median. To us, this indicates persistence of supply shocks.

“Second, over the months ahead, supply augmenting measures taken by the government should mend disruptions and imbalances, alleviating some cost pressures, but the pass-through of imported price pressures to retail prices remains incomplete.

“Third, turning to second order effects, house rentals remain subdued and rural wage growth is muted, but rising staff costs suggest that incipient wage pressures are building in the organized sector as workplaces fill up.

“Our surveys of the manufacturing, services and infrastructure firms are also pointing to an increase in selling prices in the period ahead,” said Patra.

Steering inflation levels

Taking into account the outlook on growth and inflation and keeping in mind the inherent output costs of disinflation, he felt that it is pragmatic to envisage a glidepath along which the monetary policy committee (MPC) can steer the path of inflation into the future.

“The envisaged glidepath should take inflation down to 5.7 per cent or lower in 2021-22, to below 5 per cent in 2022-23 and closer to the target of 4 per cent by 2023-24.

“The rebalancing of liquidity conditions will dovetail into this glidepath, but the choice of instruments is best left to the judgment of the RBI with its considerable experience with such tapers,” Patra said.

Liquidity management

The Deputy Governor emphasised that the RBI will remain in surplus mode and the liquidity management framework will continue in absorption mode.

“It is our hope that credit demand will recover and banks will get back to their core function of financial intermediation as soon as they can. This is the natural and the RBI-preferred manner in which surpluses in the LAF can be reduced,” he said.

VRRR debate

Patra drove his message home that the suggestion to adjust the reverse repo rate (the interest rate at which banks park short-term surplus liquidity with RBI) asymmetrically relative to the repo rate (the interest rate at which banks draw short-term surplus liquidity from RBI) was made by an external member of the MPC.

Furthermore, market participants also gave RBI similar feedback in pre-policy consultations.

“In effect, the RBI followed this counsel and the written resolutions of the MPC not just in letter, but also in spirit. By no means is the asymmetric corridor cast in stone.

“As normalcy returns, markets will return to regular timings. They will require normal liquidity management operations and a regular and symmetric LAF (Liquidity Adjustment Facility) corridor, as envisaged under the liquidity management framework announced in February 2020,” Patra said.

Also see: Indian economy may grow at 7.2 per cent constrained by Covid-19: UNCTAD

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.

Referring to one argument that variable rate reverse repo (VRRR) auctions, whereby RBI absorbs surplus liquidity from banks for 14-days, are effectively a way of remunerating excess reserves, thereby injecting additional liquidity into the system, Patra emphatically said, “It is not, and I would emphasize this, it is not a signal either for withdrawal of liquidity or of lift-off of interest rates.

“Signals of the latter will be conveyed through the stance that is articulated by the MPC in its future resolutions,” he added.

Published on September 16, 2021

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