Implicit & explicit: RBI policy statement is all about forward guidance

The RBI policy statement is all about forward guidance: both implicit and explicit. First, the RBI shift from time-based guidance to state-based guidance is a commitment to support growth in an implicit manner in the current uncertain environment. Time-based is more explicit, state-based is more implicit. For example, growth on a durable basis is not quantifiable but merely an implicit guidance on the state of the economy. Second, the explicit guidance of a guaranteed liquidity in the secondary market. Interestingly, such an assured OMO support was resorted to by Bank Indonesia and BSP (Central Bank of the Philippines) in 2020, but in the primary market. The assured liquidity support is, however, a clear resemblance to developed market central banks. Thus, the RBI has nicely dovetailed a liquidity strategy specific to the Indian context.  

One challenge that the RBI might have to face in FY22 is the movement in exchange rate. Increasingly, the current scenario reminds us of the 2008-09 playbook. International commodity prices at that point had increased at a much faster rate than the rate of appreciation in the exchange rate. As a result, the rupee movement had reversed from appreciation to depreciation in a very short span. Perhaps this exactly happened in April, when rupee depreciation has gathered pace after strong appreciation in March 2021.  

In this context, it might be worth mentioning the current RBI exchange rate policy. Unabated capital flows warrant sterilised intervention to avoid exchange rate appreciation. This sterilisation, however, needs to be in the forward market ($48 billion in forward market in FY21) rather than the spot market, as the latter will tighten liquidity conditions. Repeated intervention in the forward market raises the forward premia, as it raises future dollar demand. Through the interest rate parity condition, a higher forward premium will intrinsically reflect in higher short-term rates, which attracts further inflows. Thus, there is always a threshold beyond which forward intervention is self-defeating. It may be noted that this forward market intervention strategy by central banks (including RBI) bears uncanny similarity to John Sparos (1959). Going by John Sparos, the best way to fight currency speculation is to deliberately let the forward premia rise to unreasonable levels and thereby penalise currency speculators as their exchange rate expectations about a depreciating domestic currency are belied.

Meanwhile, the policy also has several important announcements on the development front. Regarding the payment system infrastructure, RBI has proposed to enable payment system operators, regulated by RBI, to take direct membership in CPSs. This facility is expected to minimise settlement risk in the financial system and enhance the reach of digital financial services to all user segments. RBI has also increased the account limit and made interoperability mandatory for full-KYC PPIs and for all payment acceptance infrastructure. This will increase the use of the existing payment infrastructure and will boost digital transactions in the country. To encourage farm credit to individual farmers against pledge of agricultural produce and leverage the inherent safety of Negotiable Warehouse Receipts /eNWR, RBI has enhanced the loan limit from Rs 50 lakh to Rs 75 lakh per borrower. This will increase the overall loan amount to allied activities in agri lending, which was merely Rs 437.9 crore in FY20,  against 1.4 lakh eNWR issued.

The author is group chief economic advisor, SBI