As widely expected, the RBI held the policy rate steady at 6.5 per cent in a decision released on October 6, 2023. The stance of the policy — withdrawal of accommodation — was also kept unchanged. Together with the voting pattern — unanimous for the policy rate and one dissent for the stance — the outcomes of this bi-monthly meeting of the rate-setting MPC were identical to those of the previous meeting held in August.

However, the undertone of the statements accompanying the policy was slightly more hawkish than previously. The equity market rose modestly after the policy, possibly on account of unchanged growth and inflation outlook for 2023-24. However, the price of government securities fell, with the YTM of 10-year benchmark G-Sec rising by 8-9 basis points.

The RBI has kept unchanged the growth and inflation projections for 2023-24 and Q1 of 2024-25 vis-à-vis those made in the August policy. The risks are also evenly balanced, as before. Although the headline inflation surged to 7.4 per cent and 6.8 per cent in July and August 2023 respectively on account of significant increase in the prices of a few vegetable items, the RBI expects it to moderate considerably in the third and fourth quarters of FY24.

Downward trajectory of the core inflation since January, when it had reached a high of about 6.3 per cent has given some comfort and confidence to the RBI in this regard.

Significantly, in the statements of this policy meeting, the RBI has articulated its position on inflation targeting in a more precise and straightforward manner than was the case in the previous policy releases. Two important clarifications and assertions made in this regard are noteworthy:

(a) The RBI’s monetary policy remains resolutely focused on aligning inflation to the 4 per cent target on a durable basis, and

(b) The inflation target is the headline CPI. The RBI will be in “absolute readiness to take appropriate and timely action to prevent any spillovers from food and fuel price shocks to underlying inflation trends and risks to anchoring of inflation expectations. These are non-negotiable necessities.”

These are welcome words. One hopes that the RBI will walk the talk if the need arises. Also, taking a cue from the RBI’s wise opinion that even policymakers should continue to reinforce their buffers and fundamentals, one is encouraged to say that for any monetary authority in the present-day world of fiat money, like the RBI, any buffer of consequence is its inflation-fighting record and credentials.

Call money dipping

The observation in the policy statement that the liquidity distribution in the banking system is skewed is correct. But it is not unusual. What is not in the normal order of things is that the excess and the shortfall are not getting intermediated in the call money market. ‘Elevated levels of MSF borrowings amidst substantial funds parked under the standing deposit facility (SDF)’ is only a symptom of a larger weakness: declining volumes during the last several years in the overnight call market, which is unsecured, in relation to those in the collateralised segment, involving market repo and tripartite repo (TREPS).

The operating target of monetary policy in India is the weighted average call rate (WACR) which is the most basic interest rate (being overnight and unsecured) and which can be influenced directly by the RBI.

But its comparatively low liquidity can pose a question mark to the usefulness of WACR to RBI, on the one hand. Disconnect between the call rate and the rates for higher tenors is another negative feature. The RBI is mindful of these issues and wants that banks should make more use of the call market than of SDF and MSF.

But this not going to happen simply by exhorting the banks to do so. At the heart of the issue is the fact that the banks with surplus liquidity (mostly PSU banks) have limited credit risk appetite for banks that are buyers of liquidity. This is counter-intuitive: almost all the banks with surplus liquidity lend money to non-banking financial companies of smaller size and similar or lower credit standing and for much longer periods.

The incremental CRR of 10 per cent, which was introduced on August 12, 2023 and withdrawn only after a few weeks with effect from September 9, 2023 mopped up about ₹1.1-lakh crore. This step was, by all indications, a knee-jerk attempt to deal with liquidity surplus arising out of the withdrawal of currency notes of ₹2000 denomination.

That the liquidity would tighten in September due to advance tax collection and that the demand for liquidity would go up in October in the lead up to the festive season were known at that time. In fact, the RBI was a provider of large net liquidity on many days from September 15, 2023 onwards. One can conclude that the use of CRR as an instrument for short-term liquidity management should best be avoided as doing so may blunt its efficacy in future.

The October 2023 policy announcement comes amidst significant turmoil in the global markets for equity and bonds, particularly in the US. This was occasioned by the Federal Reserve’s announcement on conclusion of its last monetary policy meeting on September 20, 2023 in which it kept the Fed Fund target rate unchanged at 5.25 -5.50 per cent range — the highest in some 22 years.

However, it indicated that it still expected one more rate hike before the end of 2023 and fewer cuts than previously indicated next year, which stance has since been captured in a catchy phrase — ‘higher for longer’. Both the equity and bond prices fell in the US and several other markets and the US dollar surged. The YTM on long-term US Treasury securities rose to a 16-year high.

It is apparent that the disinflationary forces the US central bank fought with its easy money policies in the aftermath of the financial crisis of 2008-10 have abated. Some analysts aver that the US economy is probably now characterised by inflation running higher than the Fed’s 2 per cent target, low unemployment and positive growth.

These developments will have consequences for the conduct of monetary policy in India and management of its external sector. It is too early to say anything on whether the growth-inflation dynamics in India has also undergone a similar mutation. But what is clear is that till such time the headline inflation in India is on a consistently downward trajectory from its present level, policy rate in India will stay at 6.5 per cent or even may go up by one or two more notches.

The writer is a former central banker and consultant to the IMF. Through The Billion Press