Shaktikanta Das' three-year extension to ensure policy continuity

The move also signals the government's endorsement of the policies pursued by the central bank

Shaktikanta Das’ extension for three years as the governor of the Reserve Bank of India (RBI) will ensure policy continuity and also signals the government's endorsement of the policies pursued by the central bank.

Analysts say now that Das’ reappointment is confirmed, and that too for the maximum three years permitted, a reverse repo hike can be expected in the December monetary policy.

With the repo rate at 4 per cent, and the reverse repo at 3.35 per cent, the policy rate corridor has widened to 65 basis points, from its usual 25 basis points. This has to be brought back to 25 basis points for the normal conduct of the monetary policy.

The central bank has already started its normalisation exercise despitr being cautious in terming it so. In the October monetary policy, the central bank stopped further liquidity infusion, and then with a higher quantum of variable rate reverse repo (VRRR), which will run up to Rs 6 trillion in December, the central bank will slowly remove the liquidity.

On Wednesday, the central bank announced a 28-day VRRR, in addition to its 14-day VRRRs. The idea is to keep liquidity out of the system for a longer period. VRRR, as Das had explained in his speech during the monetary policy press conference, is voluntary, but given the incentive of higher returns, all the past VRRRs have been successful.

The VRRR money technically comes back into the system after the end of the tenure, but the central bank can again announce another round of VRRR and remove the excess cash.

In the same monetary policy press conference, RBI Deputy Governor Michael Patra had talked about three-step policy normalisation — stopping liquidity, removing liquidity and then restoring the policy corridor. Analysts are not expecting a repo rate hike for a long time anyway, so one can expect a repo rate hike only in the second half of the next fiscal if the growth doesn’t dwindle further.

Apart from policy normalisation, the central bank has other pressing issues that the governor is expected to address, for example, the bad debt issue of Indian banks.

The RBI expects bad debts to rise for Indian banks due to Covid related stress. The good thing, however, is that banks are adequately capitalised to handle deterioration in asset quality.

Under the RBI’s macro stress tests, the gross non-performing asset (GNPA) ratio of the banking system may increase from 7.48 per cent in March 2021 to 9.80 per cent by March 2022 under the “baseline” scenario, and to 11.22 per cent under a “severe stress” scenario, but banks have sufficient capital to take care of it “both at the aggregate and individual level, even under stress”, the half-yearly Financial Stability Report (FSR), released by the RBI in July, said.

The RBI governor must also oversee Indian bonds’ inclusion in global bond indices and must deftly handle the resultant liquidity inflow, estimated to be at least $30 billion a year.

Under Das, the RBI has embarked on an aggressive policy of reserve accumulation as the RBI governor sees that as the best insurance against policy flip-flops by developed country central banks such as the US Federal Reserve, which is taking the first steps towards tapering of its monthly $120 billion bond purchase programme.

The currency would face volatility when the tapering starts in November, but Das has kept the reserves ready at nearly $642 billion (as of October 15). The aggressive reserve accumulation has caught the attention of the US Treasury Department, which has put India on the currency manipulator watch list.

The RBI also has to manage the record-high market borrowing programmes of the government, which crossed the Rs 12 trillion mark for two successive years due to Covid strain. RBI last year raised money at a 16-year low cost for the government, a remarkable achievement by the central bank, but high borrowings are here to stay and the RBI has to ensure that it doesn’t run out of tools to keep borrowing costs low. The yields, after all, have started rising as growth takes a foothold after the pandemic, but the RBI has to ensure the rates don’t rise sharply and derail the fledgling recovery taking shape in the country.