RBI avoids rocking the boat but can he take baby steps?

The six-member Monetary Policy Committee (MPC) voted to keep the repo rate unchanged and maintain the status quo. What RBI did was a strategic change in its liquidity management by announcing fortnightly auction of Variable Reverse Repo Rate (VRRR). These are intended to place orders on overnight and short-term money market rates. To be fair, the central bank has terminated the G-Sec Acquisition Program (GSAP) through which it has invested more than ₹2 trillion so far in FY22. While this reduces new inflows of liquidity, the current surplus is substantial enough to be a challenge. Governor Shaktikanta Das said, “We realize that as we are getting closer to the shore, we don’t want to rock the boat because there is a life beyond the shore.”

But long periods of high liquidity surplus are a threat to financial stability even in times of low growth. Banks are already becoming concerned about the challenges in assessing credit risk of companies. Pricing of risky loans is becoming increasingly difficult as easy money has brought interest rates to decades lows. As such, the banking sector is no longer the main financier of the industry.

There are enough indications that the unprecedented liquidity surplus that is currently in ₹9-10 trillion, feeding into asset prices. Low money market rates are pushing money slowly into the equity market through IPO-financing. The central bank itself has indicated several times how uncomfortable it is with the increased valuations in the equity market. Companies are taking loans from the bond market at low returns. Even as domestic liquidity messes with risk pricing here, liquidity on a global scale is making things more complicated, feeding into commodity prices around the world. It is clear that Indians are paying the price for this global commodity price rise through inflation. As such, economic recovery that is desirable will have its own contribution to inflation.

Aurodip Nandy, India’s economist and vice president, said, “We believe that India is on the path to an inflationary recovery – while the recovery of cyclical growth continues, the upside risk to inflation has increased, particularly in commodity prices.” With the latest jump in prices.” Nomura in an email.

Bond markets were furious at the end of the GSAP, but the response to the policy has been mostly muted. An assurance that withdrawals will be gradual may ease markets, but it remains to be seen whether the RBI can continue with its initial moves.