RBI’s tightrope walk

India’s monetary policy authorities are faced with an unenviable situation as FY22 unfolds: Pursuing contrary goals of promoting growth and keeping inflation under check. Amidst a surge in Covid cases, growth threatens to hit a speedbreaker all over again, just when high frequency indicators had begun to show signs of revival. Since March 2020, the Monetary Policy Committee has pulled out all stops in announcing liquidity enhancement measures, besides cutting the repo rate by 115 basis points. These steps have not led to any palpable improvement in bank credit offtake. If banks remained risk averse in times of negative growth, businesses too have decided to wait out the bad period by not borrowing much for working capital needs. The result was a yield curve where the short-end fell below the reverse repo level. As for the long-end, yields sharpened in March to rise above 6 per cent amidst global fears of commodity-induced inflation as well as the heightened government borrowing plan. Operation Twist, an exercise where the RBI purchases long-term instruments and sells short-term ones to keep the costs of government borrowing in check, seemed to lose effect.

Given the need to restore both ends of the yield curve, it comes as no surprise that the RBI has unveiled a new instrument to tap secondary market G-Secs (G-SAP 1.0). As for the short end, the reverse repo window will continue to see variable rate reverse repo auctions. It has decided to extend some credit and liquidity boosting steps beyond the March 31 deadline. This includes the targeted long-term repo operations for NBFCs (under which banks borrow at the policy rate to invest in NBFCs) by another six months in view of their interface with small businesses, which is a positive move. States’ Ways and Means Advances limits have been raised, which is welcome in view of Covid-induced fiscal stress they are facing. However, it is worth wondering whether a credit-driven approach to revival has reached its limits. The MPC is likely to hold rates as long as inflation keeps close to the upper end of 6 per cent. What remains in its liquidity toolkit is a matter of conjecture.

Imported inflation seems to have played a major role in the recent surge. The RBI cannot do much here as the price rise in cost-push in nature, save allow the rupee to appreciate. However, there is also the prospect, as hinted by RBI Deputy Governor Michael Patra, of an outflow from emerging markets. Imported inflation is best tackled by fiscal policy in the form of reduced taxes and tariffs on fuel. In any case, it would seem that the MPC has done quite ‘all it takes’ to deal with the Covid debacle. The onus now lies on fiscal policy to deliver on both growth as well as inflation reduction.

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