MPC Minutes: 'Swiss Knife-Like' Policy Tools May Win Over Sledgehammer Of Rate Hikes
A majority of India's Monetary Policy Committee continues to think that accommodative monetary policy and low interest rates are appropriate for an economy recovering from bruises of a once-in-a-lifetime pandemic.
Yet, committee members suggest that a slow process of normalisation should continue, using what Reserve Bank of India executive director called "Swiss knife-like" policy tools.
At its last meeting in December, the MPC kept the repo rate unchanged at 4%, while the reverse repo rate was retained at 3.35%. However, the RBI decided to step up liquidity absorption under its variable rate reverse repo auctions, which effectively pushes up short-term rates in the market.
Omicron Uncertainty, Growth Sacrifice
In weighing a decision to normalise policy in response to stabilising economic conditions and emerging inflation pressures, MPC members seemed to fear the growth sacrifice that such a policy move would entail.
RBI Governor Shaktikanta Das reiterated that continued policy support is warranted for a durable, broad-based and self-sustaining rebound. "It is prudent to watch out for growth signals becoming well entrenched while remaining vigilant on inflation dynamics," Das wrote.
The hesitancy to normalise policy quicker was compounded by uncertainty around the impact of the Omicron variant.
The calibration and timing of a monetary policy response and preventing build-up of financial stability risks are very important in such an uncertain environment.Shaktikanta Das, Governor, RBI
Deputy Governor Michael Patra said the level of GDP is barely at the pre-pandemic level, which itself marked a quarter in which India saw the slowest growth in six years. Consumption spending remains weak, private investment is timid and contact-intensive sectors are "still convalescing", he wrote. "The second half of 2021-22 may not be the same as the first half and moderation in the recovery could set in."
Inflation, meanwhile, could peak in the last quarter of this year and moderate thereafter. "India’s inflation developments reflect a scissor effect—rebound in demand colliding with supply bottlenecks," Patra said. By the second half of 2022, supply disruptions should normalise and pent-up demand should ease, he said.
The biggest risk of contagion is now from the new variant. Unless a clearer picture emerges on the near-term outlook, we must take guard and resume battle readiness again.Michael Patra, Deputy Governor, RBI
The key question, wrote Mridul Saggar, executive director of RBI, is whether the economy can entail the output sacrifice higher rates may bring at a time when the recovery is nascent. "Therefore, it will be best not to risk strengthening stagflationary impulses that already are being propped up by supply disruptions."
One month’s data suggesting strong growth and inflation momentums is not sufficient to change rate cycles or policy stance. This guiding rule has helped us avert the mistake of premature tightening on at least two earlier occasions.Mridul Saggar, ED, RBI
Swiss Knife-Like Steps, Eye On Liquidity
While the MPC's deliberations suggest that a hike in rates is some distance away, the RBI may continue to fine-tune policy through the liquidity and financial market channels.
Appropriate liquidity levels are key to monetary adjustment at this stage, said Saggar, adding that this is important to address unintended effects of easy liquidity such as asset prices inflation, income inequalities and risk of macro-financial imbalances.
The central bank possesses "Swiss knife-like policy tools" to deal appropriately with the emerging trends, Saggar said.
MPC member Ashima Goyal, too, highlighted the need to continue adjusting liquidity policies.
Goyal wrote that there is steady progress in fine-tuning and control of liquidity since earlier this year. Since the share of VRRR has gone up, the weighted average reverse repo rate is higher and some other short rates have risen, she said. "Additions to durable liquidity have stopped."
The next step is to decrease excess durable liquidity itself. Some of this will be absorbed as growth rises. Banks are already raising some deposit rates in anticipation of a rise in credit.Ashima Goyal, MPC Member
The Lone Dissenter
JR Varma remained the lone dissenter in the committee. Just as in the previous two policies, Varma argued that monetary policy is no longer the right instrument to deal with the economic impact of the Covid-19 pandemic.
"...the economic effects (as opposed to its health effects) have diminished greatly and become more concentrated in narrow pockets of the economy," said Varma, adding that there is no evidence to believe the Omicron variant would change the picture materially.
Varma opposed the accommodative stance and the decision to keep the reverse repo rate at 3.35%. He, however, said that a policy rate of 4%, which implies a negative real rate of 1-1.5%, is appropriate for reviving economic growth without excessive risk of an inflationary spiral.
Raising effective money market rates quickly towards 4% would demonstrate the MPC’s commitment to the inflation target, help anchor expectations, reduce risk premia, enhance macroeconomic stability, and allow lower long-term interest rates to be sustained for longer thereby aiding the economic recovery.JR Varma, MPC Member