India’s monetary maze, and the calibrated exit we need

The US Federal Reserve has indicated that it will soon begin to ease the pace of its balance sheet expansion. The European Central Bank has also said it will begin slowing its asset purchases in the last quarter of this year. Some small central banks in countries such as Brazil, Iceland, Mexico, Chile, Russia and Hungary are raising interest rates. They are joined by Colombia, Jamaica, Peru, the Czech Republic, Paraguay and Kazakhstan. Norway recently became the first Western economy to actually raise interest rates rather than absorb excess liquidity.

Some, such as the central banks of Australia, New Zealand and Israel, have postponed their exit from monetary expansion due to the unexpected new outbreak of Covid, but the direction they are headed is clear. China remains a major exception. Experience shows that central banks find it easier to initiate monetary expansion in response to a crisis; On the contrary, it is difficult to get out. Coordination among central banks is even more complicated, as economies recover from a setback at different speeds, as was the case with the North Atlantic financial crisis a decade ago, as well as the Covid shock in these times. Former Reserve Bank of India (RBI) governor D. Subbarao once said that central banks in Chakravyuh are like Abhimanyu – they know how to enter the system of monetary expansion but are less clear about exiting .

All this is the background against which the Monetary Policy Committee of India (MPC) will meet this week and decide on its next course of action. Its six members will meet at a time when public discussion has focused on the nature of monetary policy exit. There are some straws in the air. RBI is increasing the rate at which it is accepting offers under its Variable Rate Reverse Repo. It has kept the net liquidity impact of its G-Sec acquisition program at zero by selling and buying equal amounts of government bonds over the past two weeks.

At the MPC’s August meeting, Jayant R Verma disagreed with his MPC colleagues and in his dissent note argued for a change from a liberal monetary policy stance as well as an increase in the reverse repo rate (which is technically outside the MPC). Gave. Control).

It will be shown in the coming days whether the opinion of the MPC majority has started to shift in that direction, though a one-time hike in the repo rate is not expected or required as of now. An increasing number of private sector economists are now anticipating a gradual onset of policy normalization. A survey of 14 private sector economists by Business Standard’s Anup Roy shows a wide divergence of opinion on which button the Indian central bank first – a reverse repo rate hike, either a reduction in the G-Secs acquisition program or Closing, liquidity normalization, a calendar for the Indian version of the taper, forward guidance on monetary policy normalization, and high-duration variable-rate reverse repos.

The RBI took the lead in the policy response to the economic slowdown after the pandemic hit Indian shores. The size of its balance sheet is now nearly 53% higher than it was two years ago, going up from ₹41 trillion as on 27 September 2019 ₹63 trillion on 24 September 2021. The RBI balance sheet now accounts for about 28% of India’s estimated nominal GDP for the entire financial year ending March 2022. This is about six percent higher than pre-pandemic levels, and is at the high end. limit in the last 35 years. It is important to remember that there are still six months left for the current financial year to end, so it is quite possible that further purchases of local bonds as well as foreign currency assets will push the balance sheet of the Indian central bank into uncharted territory. . There is nothing sacrosanct about the upper historical range, but it is a useful marker at a time when inflation has been above the central point of the inflation target band for more than 20 months.

The first step in India’s journey towards policy normalization would be to focus on removing some of the excess liquidity in the domestic money market, changing the monetary policy stance from accommodative to neutral, and increasing the reverse through RBI’s policy corridors. focus on generalization. repo rate.

The last step would be an increase in the repo rate. This is likely to be done only in 2022, especially since domestic private sector demand is still uncertain. In its September bulletin, the RBI pointed out that the pace of monetary tightening in emerging markets depends on the situation on the ground. Countries that are commodity exporters, which have made gains in terms of trade and have made good progress with vaccination coverage, have generally been on the front of monetary tightening.

Niranjan Rajadhyaksha is a member of the Academic Board of Meghnad Desai Academy of Economics