RBI Monetary Policy: To act or to wait?

Half the respondents to CNBC-TV18’s poll said that the RBI would hike the reverse repo rate in December itself, 40 percent said it may only hike by the February policy next year and the remaining voted for a reverse repo rate hike by April.

Reverse repo, or the rate at which RBI borrows from banks, has been the operational rate for a while now. This is because the system liquidity is in “surplus”. Surplus liquidity occurs where cash-flows into the banking system persistently exceed withdrawals of liquidity from the market by the central bank. In such a scenario, banks tend to park excess funds with RBI at the reverse repo rate, which then becomes the benchmark rate for markets. In the opposite scenario, when liquidity is “tight”, and withdrawals of liquidity from the market by the central bank exceed cash-flows into the banking system, banks tend to borrow from RBI or from other lending institutions. In this case, repo rate becomes the operational rate.

RBI has kept the system liquidity in surplus since COVID to manage the government’s extraordinarily large borrowing program during the pandemic, and protect the system from any shocks. The average daily net absorption under the liquidity adjustment facility (LAF) stood at Rs 7.6 lakh crore in November. Thus, reverse repo has remained the operational rate, although now things are starting to change with RBI’s calibrated normalisation.

RBI has started reducing the liquidity excess in the system through instruments like the variable reverse repo rate or the VRRR. The average rates under recent VRRR auctions have risen to about 3.95 percent, which is close to the repo rate of 4 percent. Even if the RBI hikes the reverse repo rates now, it may not affect the markets significantly.

However, experts argue that the policy corridor, or the gap between repo rates and reverse repo rates, is typically kept at 25 basis points, or a quarter of a percentage point in normal circumstances. This was increased to 65 basis points last year when RBI cut the repo rate to 4 percent and the reverse repo rate to 3.35 percent amid the pandemic. Now, there may not be a reason to keep the corridor this high.

A hike in repo rate, which is currently at a historic low of 4 percent, would be step two after the reverse repo is hiked and policy corridor narrowed. Of the total respondents, 70 percent expect that to only happen by the first quarter of the next fiscal. RBI may want to wait for a full recovery to take shape before it starts to hike repo rates.

No change is expected in RBI’s accommodative stance yet, and most expect RBI to not even signal any change in stance in future in the December policy.

Of the total respondents, 90 percent expect RBI to stick to its 9.5 percent GDP forecast for the full FY22 for now, with some expecting an upward revision on the back of better-than-expected Q2 GDP numbers. India’s gross domestic product (GDP) grew by 8.4 percent in the July to September quarter, compared to a 7.4 percent contraction a year ago, with gross value added (GVA) rising 8.5 percent.

Inflation is also seen inching up. India’s retail inflation as measured by Consumer Price Index (CPI) rose to 4.48 per cent in October from 4.35 per cent a month ago as food prices inched up along with high input costs, fuel and commodity prices. Going ahead, hike in telecom tariffs as well as increased GST on apparel and footwear could further push up prices. 60 percent of respondents to CNBC-TV18’s poll said RBI’s CPI forecast of 5.3 percent for FY22 may be increased to 5.4 to 5.6 percent.

All respondents also expect the central bank to continue to use VRRR auctions to drain excess liquidity from the system.

The markets will keenly await RBI’s comment on the impact of the Omicron variant, even if it is early days yet. Some of the respondents said they would watch out for any further reduction in risk weights to select sectors, and perhaps comments on caution relating to NBFC funding fintechs.