The Reserve Bank of India (RBI) left nothing to surprise today and investors have been comforted by a fairly firm policy stance.
Monetary policy rates have remained intact, and even the stance has not changed in the face of various challenges that lie ahead.
What Governor Shaktikanta Das did was continue to ensure that the central bank is aware of everything. So far, you’ve found that excess liquidity has not led to undesirable outcomes beyond money markets. Das also believes that the current tools used by the central bank are sufficient to prevent liquidity from fueling unpleasant risks. His deputy Michael Patra also pointed out that the central bank does not want to intervene too much in the markets.
“Legislators were likely concerned that specific measures to drain liquidity and correct distortions in money market rates could be misinterpreted as a policy signal, leading to premature tightening of financial conditions and tightening of bond yields, “Radhika Rao, India economist at DSB Bank, wrote in a note.
In fact, what Das did was to ensure that the surplus liquidity reaches a broader set of borrowers by extending specific long-term buybacks to all sectors that the government has covered in its credit guarantee scheme of emergency. In essence, banks have more incentive to borrow cheaply from the RBI and to lend to vulnerable sectors.
However, this does not resolve the immediate concern of a steeper-than-expected yield curve. As noted earlier in this column, the spread between the one-year government bond and the benchmark 10-year bond yield has widened in the last month. As such, the spreads between holdings beyond one year have been wider, making the yield curve steeper. While Das has said that a variety of instruments would be used to manage liquidity, there has been no indication that the RBI is going beyond what has already been used. Until now, the central bank has used its liquidity adjustment facilities (LAF), operating drafts and open market operations to manage liquidity. “The RBI may find these operations limited by not having or not wanting to use tools to sterilize some of these interventions,” Rajeev Radhakrishnan, head of fixed income at SBI Mutual Fund wrote in a note. Radhakrishnan added that this could keep the yield curve steeper.
A steep yield curve reflects expectations that interest rates will rise in the medium term. That brings us to inflation that has been above the mandatory RBI target for five months. The RBI has raised its forecast for retail inflation and now expects it to be 6.8% in the current quarter and 5.8% in the fourth quarter. Das emphasized that targeting inflation remains the top priority for the MPC and the central bank. What this means is that the RBI can hold rates for an extended period of time. It remains to be seen to what extent next year the monetary policy committee will be able to abstain from voting in favor of the adjustment.
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