Rate hikes won't arrest rising fuel and commodity prices, which in turn is stoking inflation. So channelling Sherlock Holmes' elementary logic, the RBI's Monetary Policy Committee (MPC) unanimously left the policy rates and stance unchanged on Friday.
But the geopolitical tensions have fluttered the dovecotes at the RBI, who raised the FY23 inflation outlook by a steep 120 bps to 5.7% as against the previous estimate of 4.5%.
Caterwauling about inflation, Governor Shaktikanta Das emphasized that meeting the inflation target will take precedence over growth. This is a significant departure from the pandemic-focused policy of the past two years, when the RBI has set out its stall and philosophy clearly to go decidedly after growth.
In other words, Das' hawkishness signals his readiness to switch policy gears (read rate hikes) in the coming months. For added emphasis, he concluded his Friday morning policy statement with this: We are not hostage to any rule book and no option is off the table, when the need of the hour is to safeguard the economy.
The foremost thing the RBI, or any central bank for that matter, wants to crack is the low inflation-high growth matrix. But right now, we are at the other extreme with high inflation-low growth, and the protracted supply disruptions and cost pressures will likely linger longer.
Here's where the governor's statement sounded somewhat discordant, with the MPC sticking to an accommodative stance, yet emphasising inflationary concerns and beginning withdrawal of accommodation. Clarifying the thought process, Deputy Governor Michael Patra later explained that the central bank was only withdrawing its ultra accommodative stance, where the real policy rate is set to zero. Even after lifting the ultra-loose policy, Patra said, they will still have room to remain accommodative. In a sense, as Patra observed, the central bank is preparing for both sides of the situation, but for now the move towards positive real rates has well begun. This should bring cheer to savers, whose real return on savings remained negative for quite sometime now.
The conflict in Europe could derail the global economy, Das said, perhaps implying that FY23 got off to a ropy start. Even though he offered reassurance about the Indian economy's strong buffers in terms of large forex reserves, improvement in external indicators and strengthening of financial sectors, we are caught in the global cross-currents and so FY23 real GDP forecasts were revised downwards to 7.2% as against 7.8% projected earlier. This was reason enough for bond markets to snarl and within seconds after Das' remarks, the benchmark 10-year bond yield breached 7% -- the highest since 2019 -- while the rupee rose against the US dollar.
Meanwhile, the season's first bi-monthly monetary policy review stood out not for retaining the status quo or revising inflation and growth outlooks, but for pulling a rabbit out of the hat.
On Friday, the central bank officially began policy normalisation, by bringing in a new tool. While repo and reverse repo rates are held at 4% and 3.35% respectively, the central bank restored the LAF corridor to 50 bps, introducing the Standing Deposit Facility (SDF) at 3.75%. This window will allow banks to park excess reserves. Until now, liquidity was being absorbed under the reverse repo window, but from hereon, SDF will subsume the role. Unlike reverse repo, SDF is more flexible and needs no government securities as collateral.
According to Das, policy normalisation shouldn't come as a surprise as 80% of the liquidity is being absorbed at close to the repo rate at 4%. Put another way, the central bank has prepared the market for normalisation over the last several months and contain volatility.
As for injecting liquidity, Das pointed to the Marginal Standing Facility (MSF) rate, which is set 25 bps above the repo rate at 4.25%. In sum, both ends of the LAF corridor will have standing facilities, one to absorb liquidity and the other to inject liquidity, and depending on the evolving financial market conditions, banks can access either MSF and SDF at their discretion.
Lastly, the RBI will pursue its nuanced and nimble-footed approach of managing liquidity using the two tools -- VRRR auctions of varying maturities to absorb liquidty and VRR auctions to manage transient liquidity. As for the Rs 8.5 lakh crore liquidity overhang, the central bank will engage in a gradual and calibrated withdrawal of excess liquidity over a multi-year timeframe in a non-disruptive manner beginning FY23.