The policy rates have been left unchanged and the policy stance remains accommodative. The Governor opened his statement like this – economic growth is good and better than other countries, inflation is still within the threshold set by the RBI, and the pandemic is still a threat, and therefore, the need to protect lives and livelihood.
The policy does not reveal any major departure from the earlier approach while the normalization and realignments remain where they are and as they are. As you may recall the normalizations started in Jan-Feb 2021 and culminated with the Variable Rate Reverse Repos by which liquidity absorption was accelerated in Aug 2021. The central bank will continue to use the VRRRs as an instrument of liquidity management.
The four factors that are likely to be at play as we progress into the next financial year are as follows:
MARKET RATES
The market rates and yields have moved up in the last three months, not on account of RBI stance or policy, but on the basis of emerging economic and market realities. The rates at the short end as well as the long end have moved up. This would have required a realignment of the repo rate. The effective reverse repo rate has moved up from 3.35% to 3.87% over the last 5 months. Probably this may be achieved in subsequent policy announcements. The one-year CD and CP rates, as well as the Ten-Year benchmark rates have also surged.
GLOBAL RATES
Bond yields have moved up in international markets in response to higher growth and higher inflation. Bank of England has hiked the base rate twice in the last two months. The US Fed has already indicated its readiness to up the base rate in the coming months to contain spiralling inflation. This rise in inflation and rise in rates, and the record high prices in Brent cannot be ignored. These factors are bound to put pressure in the domestic economy and markets too.
FISCAL DEFICIT
The fiscal deficit for the current year is placed at 6.90%, while the same for the next financial year is put at 6.40%. The budget also affirms the intention to move to a level below 4.50% by 2025-26. But the high fiscal deficit has been highlighted by rating agencies as a potential quarter from which issues could crop up gradually.
GOVERNMENT BORROWING
The gross government borrowing program is higher from Rs.12 lakh Crs to Rs. 14.95 lakh Crs. This reflects the extent to which the government will have to approach the markets for raising resources through market borrowings. In the recent years, the issue of primary securities sailed through quite smoothly due to the easy liquidity conditions, the GSAPs, and the other support measures which the RBI provided. It is doubtful whether the same level of support would be possible with higher inflation.
THE RATIONALE
RBI has projected a moderation in inflation to 4.50% in 22-23, as demand pull pressures are muted, and average inflation for FY21-22 is retained at 5.30% “The MPC also noted that consumer price inflation has edged higher since its last meeting, but largely along anticipated lines. The increase in inflation in December was entirely due to unfavorable base effects despite month-on-month decline in prices. Large buffer stocks of cereals and effective supply side measures augur well for food inflation. Core inflation remains elevated, but demand-pull pressures are still muted. The renewed surge in international crude oil prices, however, needs close monitoring…. On balance, headline inflation is expected to peak in Q4:2021-22 within the tolerance band and then moderate closer to target in H2:2022-23, providing room for monetary policy to remain accommodative.”
On growth, the RBI says, “Domestic Growth, the real GDP growth at 9.2 per cent for 2021-22 takes it modestly above the level of GDP in 2019-20. Private consumption, the mainstay of domestic demand, continues to trail its pre-pandemic level. The persistent increase in international commodity prices, surge in volatility of global financial markets and global supply bottlenecks can exacerbate risks to the outlook.” Therefore, sustaining growth at higher levels continues to be a priority for the markets.
IMPACT
The policy has a positive impact on the economy and markets in the immediate term. But this may be short lived. The realities of a massive government borrowing, higher crude oil prices, and probably pick up in credit would all put pressure on the market rates. However, it may be mentioned here that, though the RBI does not make any mention of the tasks ahead in terms of borrowing next year, by retaining an accommodative stance, the bank has kept the options open for specific liquidity actions in future to support government security primary issues, if required.
