RBI MPC: Letting Go Of Ultra-accommodation

The RBI has finally crawled towards change in policy stance by being "less accommodative" even as it kept the policy repo rate unchanged with a unanimous vote. The move towards the stance adjustment has come from adding overnight SDF as a new instrument to liquidity management framework at - 25bps of repo rate to absorb liquidity, symmetric with MSF rate which is at +25bps higher than repo rate.

However, RBI also maintained that they will continue to adopt nuanced and nimble approach to liquidity management even as they more towards normalisation going ahead.

We had argued in our thought piece a quarter ago that time is ripe for SDF introduction, which would not only alleviate the collateral constraint but if effectively used, could have multiple benefits in policy flexibility on financial stability and for banking sector as well.

The journey from current Rs8tn+ system liquidity to a pre-Covid Rs2tn+ will be a long-drawn one and new tools like SDF will be needed to manage durable liquidity/any idiosyncrasies amid collateral constraints under VRRRs.

That said, the fixed reverse repo rate (FRRR) at 3.35% , even though adds a lower overnight bias to policy corridor, now becomes largely redundant as now it is going to be used at the discretion of the RBI. Nutshell, the move would ensure the call money rate would eventually edge towards the new effective corridor of 25bps -/+ Repo rate.

Amid new macro realities, the inflation forecast has been made more realistic at 5.7% from 4.5% earlier (Emkay: 5.8%+) with Brent at $100/bbl and higher commodity complex in general, which again adds bias to their move towards policy rationalization. The growth looks to be printing the lows of 7.2%, with further persistent slack. Inflation has been given more priority over growth.

Overall, the policy calibration is well appreciated -- crawling towards withdrawal of "ultra accommodation", with policymakers making the liquidity normalisation long drawn multi-year process. However with reaction function pivoting back towards inflation over growth as policy priority, the policy bias is clear.

Thus, to that extent RBI no longer remains a stout dove and the reaction function is now evolving with fluid macro realities.

The policy change in stance could formally change in the following policy, even as the RBI crawl gradually towards normalisation of liquidity. This also raises chances of rate hike commencing from Aug policy.

(About the author: Madhavi Arora is the Lead Economist at Emkay Global Financial Services)