Supporting growth

Govt action will be more important than monetary policy

The outcome of the bi-monthly meeting of the Monetary Policy Committee (MPC) was on expected lines. The rate-setting committee of the Reserve Bank of India (RBI) on Wednesday decided to leave the policy repo rate unchanged and maintain an accommodative stance as long as necessary to support economic growth. The steps required to unwind excess policy accommodation at this stage are anyway outside the purview of the MPC. The MPC’s assessment of the macroeconomic situation also remains broadly unchanged, though uncertainty has increased with the discovery of a new variant of Covid-19. It expects the Indian economy to grow at 9.5 per cent in the current fiscal year. The inflation rate is expected to average 5.3 per cent in the ongoing year. It is expected to peak at 5.7 per cent in the fourth quarter before moderating to 5 per cent in the first half of the next fiscal year.

Although the inflation rate has come down in recent months and is expected to remain within the tolerance band of the RBI, the real policy rate will continue to remain in the negative territory. Besides, the core inflation continues to remain elevated and is close to the upper end of the tolerance band. This could have implications for the headline number as the economy recovers and demand strengthens over the coming quarters. In this context, however, it is worth noting that the RBI is gradually addressing the liquidity overhang in the system. It has increased the quantum of variable rate reverse repo (VRRR) auctions. As announced earlier, the liquidity absorption under VRRR was to the tune of Rs 6 trillion on December 3. The central bank now intends to increase it to Rs 7.5 trillion by the end of this month. The idea here is to absorb liquidity largely through auctions and reduce absorption via the fixed-rate reverse repo window. The RBI will also be increasing the term of VRRR depending on broader conditions. 
 

The absorption of liquidity from the system will push up short-term rates and enable the RBI to normalise the policy corridor in a non-disruptive manner. In fact, the RBI is in a position to do that as the weighted average reverse repo rate is currently at 3.8 per cent. It is possible that the central bank wants to keep its options open as the economic outlook still remains fairly uncertain. However, at a broader level, it is now worth debating as to what extent the monetary policy can support growth. Economic activity in the second quarter of the current fiscal year marginally exceeded the pre-pandemic level, which is anyway a weak base. Growth is likely to moderate to 6 per cent in the last quarter of the current fiscal year. It would again go up sharply in the first quarter of the next year because of a lower base —economic activity in the first quarter of the current fiscal year was affected because of the second wave of the pandemic. Monetary policy has played its part in supporting the economy and the RBI will do well to complete the normalisation process. This would allow it to shift focus towards price stability. Government action would be more critical from here on in supporting and sustaining growth. Relying on monetary policy for too long can increase risks.