9.5% growth projection for whole year seems on track: RBI Dy Governor Patra

Reserve Bank will remain in surplus mode and the liquidity management framework will continue in absorption mode, he added

With India’s gross domestic product (GDP) growing at 20.1 per cent in the first quarter of FY22, the Reserve Bank of India (RBI) believes the economy is well and truly on track to achieve its projected growth rate of 9.5 per cent in the current financial year, even as there is a fierce debate on whether the elevated level of inflation is transitory or persistent.

RBI deputy governor, Michael Debabrata Patra said, “The GDP outcome for the first quarter coming in just a shade below the RBI’s forecast, the projection of growth of 9.5 per cent for the year as a whole appears to be on track",

Patra, said, “In the MPC’s assessment, inflationary pressures are largely driven by supply shocks. Although shocks of this type are typically transitory, the repetitive incidence of shocks is giving inflation a persistent character”.

The August consumer price index (CPI) inflation print came at 5.3 per cent, lower than what the RBI had predicted. The central bank had expected inflation at 5.9 per cent for the second quarter ended September, and 5.3 per cent for the third quarter ended December.

“The analysis of inflation dynamics indicates that the easing of headline inflation from current levels is likely to be grudging and uneven”, Patra said. He said, currently, contribution to inflation is emanating from a narrow group of goods –items constituting around 20 per cent of the CPI are responsible for more than 50 per cent of inflation. But, the measures taken by the central government to mitigate the supply shock issues should provide some comfort.

“Taking into account the outlook on growth and inflation and keeping in mind the inherent output costs of disinflation, it is pragmatic to envisage a glide path along which the MPC can steer the path of inflation into the future”, Patra said.

The envisaged glide path should take inflation down to 5.7 per cent or lower in 2021-22, to below 5 per cent in 2022-23, and closer to the target of 4 per cent by 2023-24. “The rebalancing of liquidity conditions will dovetail into this glidepath, but the choice of instruments is best left to the judgment of the RBI with its considerable experience with such tapers,” Patra said.

The revere repo debate

Presenting the RBI’s side on the debate that has ensued on the reverse repo being the effective rate now, which, in a way, is undermining the MPC because under conditions of ample liquidity, the RBI has to switch to an absorption mode and the effective policy rate becomes the reverse repo rate, Patra said, the pandemic has called for out of the box responses by the RBI, given that credit channel of transmission broke down because of muted demand and risk aversion.

Hence, the RBI decided to operate through other segments of the financial markets to keep the lifeblood of finance flowing. “In a situation in which the repo rate has been reduced by a cumulative 250 basis points since February 2019 and is constrained from being reduced further by elevated inflation, the reduction in the reverse repo rate eased financial conditions so much that it facilitated record levels of access to finance by corporates and governments at low-interest rates/spreads”, Patra said.

“This is a shining example of flexibility in liquidity management, complementing similar flexibility in the monetary policy framework”, he added.

He added, “As normalcy returns, markets will return to regular timings. They will require normal liquidity management operations and a regular and symmetric LAF corridor, as envisaged under the liquidity management framework announced in February 2020”.

In an interview with Business Standard, MPC external member Jayanth Verma had said “...though the repo rate is 4 per cent what has happened is that 3.35 per cent [reverse repo rate] has become the effective interest rate in the economy. This 4 per cent has, sort of, become irrelevant. The effective interest rate in the economy is not 4 per cent but 3.35 per cent.”

“The way I see it is that 3.35 per cent is lower than what is desirable. Interest rate closer to 4 per cent and sustaining that for a reasonable period is what I think is important”, he had said.

Verma was the lone dissenting member of the MPC who voted against the continued “accommodative” stance of the MPC and argued for a raise in the reverse repo rate, minutes of the August 4-6 meetings showed. He had argued that since reverse repo rate does not fall within the remit of the MPC, then the announcement of this rate should be in the Governor’s statement and not in the MPC’s statement.

Liquidity absorption

Assuaging market fears that with variable rate reverse repo (VRRR) auctions the RBI has essentially started tightening, Patra said, the RBI will remain in surplus mode and the liquidity management framework will continue in absorption mode.

“..it (VRRRs) is not a signal either for withdrawal of liquidity or of lift-off of interest rates. Signals of the latter will be conveyed through the stance that is articulated by the MPC in its future resolutions. We don’t like tantrums; we like tepid and transparent transitions – glide paths rather than crash landings”, he said.

“It is our hope that credit demand will recover and banks will get back to their core function of financial intermediation as soon as they can. Thisaid.

At the end of September up to which VRRRs auctions have been announced, the daily surplus absorbed under the liquidity adjustment facility (LAF) will still be around Rs nine trillion–the same level as today if not higher–more than half of which would still be under the fixed rate reverse repo.