MPC may opt for cut in liquidity, no rate hike: BS monetary policy poll

Economists and bond market participants do not expect the monetary policy committee (MPC) to change its accommodative stance or the repo rate on October 8 but they will keenly look for hints on policy normalisation, starting with the removal of excess liquidity.

A Business Standard policy poll of 14 leading economists and bond market participants expects the status quo. But their prognosis about other policy outcomes varied widely.

 The repo rate is now at 4 per cent, while the reverse repo rate is at 3.35 per cent. The rates have remained at a record low because of the pandemic and the RBI seems not to be in a mood to hike rates.

Notwithstanding the rate hikes by other central banks and guidance by the US Federal Reserve to reduce its bond purchases from November, the Reserve Bank of India (RBI) is unlikely to be in a hurry to act on rates.

The August print of the consumer price index (CPI) inflation came at 5.3 per cent, well within the RBI operation limits, and prices are expected to fall further in the coming months. A data-dependent RBI has officially taken a stance to continue with the accommodative policy for “as long as necessary” until signs of durable growth are visible.

Those considerations haven’t changed, and except for global central banks sounding hawkish, pushing up bond yields, nothing much has changed on the ground, say economists. Demand is coming back slowly, pushing up oil prices, but the pandemic is still not over. Economists say a withdrawal, which can again be followed by accommodative policies, will spoil the credibility of the central bank, and therefore, the RBI shall opt for wait and watch in the October policy.

Illustration: Ajay Mohanty

“We can expect the status quo on the repo rate as there are lots of uncertainties, making a clear call difficult,” says Siddhartha Sanyal, chief economist of Bandhan Bank. “True that many central banks are moving closer to hiking rates, pushing up bond yields, including in India. But the RBI’s rate cuts in 2020 were far nuanced than many of its peers. That also suggests that there won’t be any extra pressure on the MPC or the RBI to hurry on rates.”

Amid all these, the RBI’s latest cut in the 7-day variable rate reverse repo (VRRR) came at 3.99 per cent, or at par with the repo rate. This came as a clear signal to the bond market that the policy normalisation has already started, or will start soon.

The RBI accepts overnight excess liquidity from banks at 3.35 per cent, its reverse repo rate. A 7-day reverse repo fund should ideally remain anchored around 3.35 per cent, and not the repo rate.

One way that the RBI was infusing liquidity in the system was through the government securities acquisition programme (G-SAP). Through this, the RBI purchased Rs 2.2 trillion (Rs 1 trillion in Q1 and Rs 1.2 trillion in Q2) worth of bonds from the secondary market, directly injecting liquidity into the system. Now that the liquidity surplus has reached Rs 8 trillion, the RBI may stop that programme, or bring down the quantum. The RBI is already conducting 14-day and 7-day VRRR programmes to remove excess liquidity. At its peak, the VRRR reached Rs 4 trillion by the end of September.

“We expect the G-SAP to be discontinued and instead some ‘Operation Twist (where the RBI simultaneously buys and sells bonds of different maturity to control yields)’ programme to be announced for one or two months,” says A Prasanna, chief economist of ICICI Securities Primary Dealership. “The VRRR amount under the 14-day programme could be increased to Rs 5 trillion and an indication of longer-term VRRR could be given. The RBI may also increase the trading hours.”

Ram Kamal Samanta, vice president-investments, Star Union Dai-Ichi Life Insurance, expects the G-SAP amount to be halved to Rs 60,000 crore, as the borrowing calendar remained according to the budget announcement despite borrowing for states to compensate for goods and services tax (GST).

“We expect the use of least disruptive policy instrument for a gradual transition of operative policy rate from reverse repo to repo,” says Samanta.

However, Soumyajit Niyogi, associate director at India Ratings and Research, says there can be a 15-basis point hike in the reverse repo. “Too much liquidity is chasing too little demand for credit. With easing pandemic conditions, now it’s time to put more focus on stability in the financial market. Therefore, short-term rates should undergo a normalisation process.” According to Soumya Kanti Ghosh, chief economic advisor of State Bank of India (SBI), status quo is expected; he will “watch out for RBI heralding in a liquidity normalisation beginning October.”

The maturing of forward contracts in the past fortnight of close to $30 billion, coupled with the government of India spending, can add to systemic liquidity. There can be lower cash leakage this festive season because of social distancing. “Neutralising such abundant liquidity with longer-term VRRR, perhaps significantly scaling down G-SAP and moving the system towards liquidity normalisation, will set the stage for reverse repo rationalisation in subsequent policies,” says Ghosh.

Gaurav Kapur, chief economist of IndusInd Bank, says supporting the ongoing economic recovery should continue to be the MPC’s focus.

“The committee would, of course, take into cognizance the impending US QE taper announcement in November, and it would likely take comfort from the fact that abundant forex reserves would act a shock absorber and monetary policy could, therefore, remain focused on domestic concerns,” says Kapur, adding the RBI can afford to wait and watch for now.

“With the global policy tide changing and crude oil prices escalating, the underlying tone is expected to remain cautious. The forward guidance should be loaded with cues with upcoming policy normalisation,” says Upasna Bhardwaj, chief economist of Kotak Mahindra Bank.

“While we don’t expect any rate action on October 8, we expect the RBI to give a calendar of ‘tapering’ linked to its expected growth & inflation trajectory. At the margin, it will attach a higher weighting to economic recovery than to inflation,” says Rupa Rege Nitsure, chief economist of L&T Finance Group.