Time for caution

| Updated on August 06, 2021

RBI Governor Shaktikanta Das has pinned hopes on the kharif crop to cool inflation   -  PTI

Amidst inflation fears and growth concerns, RBI betrays worries about managing bond markets

The Monetary Policy Committee has held rates for the seventh straight time (repo rate at 4 per cent and reverse repo at 3.35 per cent) but has taken note of the inflation threat while sounding accommodative as usual. The accommodative policy stance is consistent with the global trend now. A resurgence of the pandemic could hurt global growth prospects by squeezing consumption and incomes, as noted by the Bank of England in its August 5 policy statement. Central banks are, therefore, wary of closing the cash spigots now. In retaining the RBI’s growth projection of 9.5 per cent for 2021-22, Governor Shaktikanta Das sounded a trifle apprehensive. The MPC has categorically said, echoing the IMF’s July statement and advisory to central banks, that it chooses to look through inflation as a “transitory” phenomenon, while focusing on the “endemic” demand constraint. It perhaps rightly attributes inflation to imported commodity prices which cannot be addressed by conventional monetary policy anyway. The Governor has expressed hope that the kharif crop would pick up, reducing food inflation. The MPC can be expected to be ‘liquidity positive’ and hold rates as long as global bond yields remain subdued. US and EU yields have fallen in recent months on lower real growth outlook (in the wake of the Delta variant).

However, the RBI should acknowledge the limits to monetary and liquidity easing as a means to spur growth. The surge in reverse repos from a daily average of ₹5.7 lakh crore in June to ₹8.5 lakh crore in August so far indicates a lack of credit appetite. An excess of liquidity is known to spur asset bubbles and financially irresponsible behaviour. Besides, negative real interest rates, as at present, hurt bonafide savers, encouraging a flight of capital into risky assets. Therefore, the task ahead for both the Centre and the RBI is akin to a tightrope walk: delivering growth by keeping inflation, asset prices and borrowing cost low.

Even if this sounds like a tall order, the RBI Governor should not betray a sense of anxiety. He did just that on Friday by saying that the Centre would not borrow from the market to pay GST compensation to States — in effect, directly addressing the so-called bond vigilantes. It is another matter that the RBI’s efforts to flatten the yield curve through successive ‘operation twists’ have not shown dramatic results so far. The RBI has done the right thing by expanding its variable rate reverse repo auctions in an attempt to suck out excess liquidity. Meanwhile, the government should ensure a bigger bang for every buck that it invests in a climate of creeping inflation.

Published on August 06, 2021

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