What changed in the budget for monetary policy

But this time things may be different. The economic survey and budget are emphasizing on growth. Earlier GDP growth rate of 8-8.5% in FY12 stood at 9.2% for FY12, which clearly points to optimism. Therefore, the MPC will be forced to reconsider its position and decide whether the growth reflected in GDP estimates and projections is sustainable. This becomes the starting point.

Inflation, rising until now, was not a major consideration for the MPC. But at more than five percent, the MPC can no longer distinguish it as being “temporary.” As delicate as the geopolitical scenario and the global oil situation is, crude oil prices are likely to rise in the coming days. financial year.

The second question that needs a fresh look in the light of the budget’s fiscal deficit projections is that of liquidity. How RBI will resolve the surplus liquidity around 6-7 trillion currently in the system with the government’s substantially increased borrowing requirement, the budget 14.95 trillion for FY23?

The riddle can be put this way: We have a situation where growth is on track and the prospect of inflation rising is clear. Therefore, monetary policy will have to be normalized and covid measures will have to be phased out, starting with an increase in the repo rate.

But there is no possibility of increase in the upcoming meeting of MPC. Instead, a good sign for the market would be to increase the reverse repo rate in the upcoming MPC meeting. (This will not increase the cost of funds.) There is a liquidity overhang in the system which RBI needs to address. As of now, RBI has converted this surplus into 3.99% return facility through VRRR (Variable Reverse Repo Rate) auction. This had to be normalized and liquidity had to be drained out of the system. Otherwise, surplus liquidity would coexist with higher interest rates, an anomaly.

The huge increase in the government’s borrowing requirements projected in the budget has already rocked the markets. Yields have increased alarmingly. Now, if GDP growth in the next year becomes high and sustainable, as predicted by the Economic Survey, credit demand will also increase from current levels. Hence, the overall demand from the private sector as well as the government will be huge. The total fiscal deficit will be 8.9% (6.4% for the center + 3.5% for the states).

It can be argued that surplus liquidity can be used for increased borrowing requirements of the government. However, lending is always done in phases throughout the year. Surplus liquidity can be absorbed faster than in calendar schemes of borrowing. In such a situation, there may be a huge shortage of funds, which can increase bond yields. The 10-year bond hit a multi-year high of 6.95% on Friday’s intra-day. The market is apparently waiting with high level of concern for RBI’s action on interest rates. Even more important than the action will be the message in the statement.

Economists generally say that fiscal policy should always speak to monetary policy; It is the combination of the two that works through the economy, and the two are not independent. This conversation, most likely, has already taken place between the RBI and the budget makers before it was presented on February 1. If so, it would make the outcome of the upcoming policy review easier. In the rare event that the dialogue has not already taken place, the MPC will have a task on hand. Then, the alternative would be to defer the difficult decision of raising the repo rate till April, when the new financial year begins. But even then, the MPC will still have to send clear signals on February 9 as to when normalization can be expected.