Monetary policy review: Experts laud RBI's recommendation for MSS bonds

The Reserve Bank of India (RBI) has called for continuation of the monetary policy framework, which was first introduced in 2016.

The MPC had mandated to keep consumer price index (CPI) inflation at 4 percent (+/- 2%). This was the agreement reached with the government for 5 years. This mandate ends on March 31, 2021.

Termed as the Flexible Inflation Targeting or FIT, this policy was largely successful. The trend inflation fell from above 9 percent before FIT to 3.8-4.3 percent during FIT. Hence, the RBI, in its Currency and Finance Report on Friday recommended that the inflation target of 4 percent (+/- 2%) be continued for another 5 years.

It has also recommended the need for market stabilization scheme (MSS) bonds to enhance RBIs sterilisaton capacity to deal with surges in capital flows.

Upasna Bhardwaj, Senior Economist at Kotak Mahindra Bank, said that MSS is the perfect tool suggested by the RBI. She added that whenever there is a deluge of capital flows, SGF, MSS should be used as a tool.

“In this current context MSS is a perfect tool which the RBI has suggested. However, at this point in time we will have to see how this really works because if MSS tool is applied, then it probably gives some kind of a leeway to the bond markets wherein RBI is in a position to again infuse liquidity through another channel to manage the bond market pressure that is there,” she said.

Sameer Narang, Chief Economist at Bank of Baroda, too believes that MSS is a good idea.

“I think it is a very good idea. We have done it in the past also; in 2004 and even in 20016 after demonetization the MSS bonds were issued so as it mop up the short end of the liquidity. I think as of now RBI is doing a switch, it is mopping up short end liquidity and injecting funds in the long end."

"I think it will be viewed positively if the central bank is only infusing liquidity in the long end. So, I think markets will look at it positively and it will also distort the liquidity at the short end of the curve which is too excessive right now in my opinion. So, I think it is a good idea,” he said.

Kaushik Das, Chief Economist at Deutsche Bank, said that he expected the government to take a cost on MSS in the Budget.

“We were surprised that there was no allocation for MSS in this Budget itself. We were actually looking at a possible MSS allocation in this Budget itself because FY21 we could have understood in between the government would not have wanted to take the cost for MSS because the fiscal deficit had already gone up and additional expenditure government would not have wanted to take."

"But for FY22 we thought the government would take some cost upfront in the Budget. It is not necessary that RBI has to use it, but at least they will have that tool if it was allocated in the Budget and then at an opportune time if they felt that instrument was necessary, they could have used it. It doesn’t stop the government from announcing MSS in between the financial year when it starts, but it would have been a good start if it was there,” he said.