Looming threat

The Reserve Bank of India’s Monetary Policy Committee (MPC) has done right in maintaining status quo on policy rates and in continuing an accommodative monetary policy stance. The new Omicron variant of the Covid-19 virus that is once again leading to lock-downs and closure of international borders has greatly increased the uncertainty regarding growth, making the central bank revise the Q3 2021-22 growth forecast to 6.56 per cent from 6.8 per cent projected in the previous meeting; the full year target is however being retained at 9.5 per cent for this fiscal. With private consumption and private capital expenditure yet to revert to pre-pandemic levels, the central bank is right in waiting for sustained growth trajectory. This is especially so as there are strong headwinds to growth caused by expected volatility in financial markets due to monetary policy normalisation of central banks, continued global supply bottle necks and elevated fuel prices.

While the central bank is right in focusing on supporting growth, it cannot shrug aside the risks posed by inflation. The inflation forecast for 2021-22 has been maintained at 5.3 per cent citing reasons such as expected correction in vegetable prices due to good rabi crop, supply side interventions by the Centre to bring down prices of edible oil and recent correction in crude oil prices. But the RBI seems to be ignoring the renewed spike in crude oil prices this week which indicates that market is not as worried about the Omicron variant as policy makers and that global demand is likely to remain strong. Similarly, elevated global prices of edible oil and high core inflation are not likely to come down in a hurry. It’s a little surprising that the RBI is continuing with its view of inflation being transitory, while other central banks such as the Federal Reserve are finally beginning to acknowledge that high inflation is likely to persist longer than originally anticipated. While the RBI is in a wait and watch mode for now, it may soon need to resort to monetary tightening to control price increases since price stability is among the significant drivers of growth.

The RBI has also not given any guidance on reducing the surplus liquidity in the system, and has instead decided to continue rebalancing the surplus by shifting it from fixed rate reverse repo window to variable reverse repo rate auctions of longer maturity. While this move will help RBI control the short-term interest rates and move them closer to the policy rate, it does not impact the overall system liquidity. It’s clear that the RBI does not want to rock the boat in any manner as of now given the growing uncertainties, but it may have to start planning monetary tightening soon, especially with other central banks embarking on this path. Allowing banks to prepay the outstanding amount availed under TLTRO 1.0 and 2.0 and withdrawing the special dispensation allowed to banks to borrow up to 3 per cent of their net demand and time liabilities under the MSF window will help reduce the surplus liquidity in the system somewhat, but it may not suffice.