RBI Policy: Aggressive Liquidity Management, Higher Short-Term Rates

The RBI policy announcement has retained the policy rates unchanged, with Repo Rate and Reverse Repo Rate at 4.00% and 3.35% respectively. The policy underlines the commitment to pursue an accommodative stance for an extended period of time to support economic growth, while pursuing the liquidity normalization.

As expected, the liquidity management aspects get more attention in this policy as the Variable Rate Reverse Repos will be to the tune of Rs.7.50 lakh Crs by Dec 31, 2021. This indicates a substantial amount of liquidity being taken out of the system, and the pruning of the liquidity availability factor in the coming months. This may have an impact on the short-term rates, including the overnight and the call money rate, both of which are a function of supply and demand for liquidity. This signals a more aggressive approach to liquidity management by the central bank signalling a departure from the soft money policy that it followed so far. But still, it is too far from a hike in rates.

On Growth, the RBI perceives the major challenges to growth are as follows: “Downside risks to the outlook have risen with the emergence of Omicron and renewed surges of COVID-19 infections in a number of countries. Besides, notwithstanding some recent corrections, headwinds continue to be posed by elevated international energy and commodity prices, potential volatility in global financial markets due to a faster normalisation of monetary policy in advanced economies, and prolonged global supply bottlenecks.” The GDP growth projection is retained at 9.5 per cent in 2021-22, consisting of 6.6 per cent in Q3 and 6.0 per cent in Q4 of 2021-22.

On inflation, the RBI maintains that the likelihood of higher inflation cannot be ruled out. RBI policy states – “Though crude oil prices have seen some correction in the recent period, a durable containment of price pressures would hinge on strong global supply responses to match the pick-up in demand as pandemic restrictions ease. Cost-push pressures continue to impinge on core inflation, though their pass-through may remain muted due to the slack in the economy. Over the rest of the year, inflation prints are likely to be somewhat higher as base effects turn adverse…”. The inflation projections from the RBI points to a potential for higher inflation in the coming days – the CPI is put at 5.30% 2021-22, 5.10% for Q3, and 5.70% for Q4 of FY22. Thereafter, inflation is expected to ease to 5.00% in H1 of FY23.

As the liquidity normalization process intensifies, and as inflation pressures remain elevated, yields are likely to move up gradually. Therefore, the approach to investments remains unchanged with an accent on the short end of the curve, like short term funds and corporate bond funds, as also accrual funds with a high credit quality portfolio. There is a shift in many overseas economies from an easy money policy to a tighter stance, especially in the US. This may also have some influence on the trajectory of our policy and the market rates.


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