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The central message from the Reserve Bank of India’s (RBI) monetary policy on Friday was this: we can see the shore of growth now but we won’t give up accommodation until we reach there.

The six-member monetary policy committee (MPC) voted to keep the repo rate unchanged and the stance as is. What the RBI did was tactical changes to its liquidity management by announcing fortnightly auctions of variable reverse repo rate (VRRR). These are aimed towards bringing order to overnight and short-term money market rates. To be fair, the central bank has ended the G-sec acquisition programme (GSAP) through which it infused more than 2 trillion in FY22 so far. While this reduces fresh infusion of liquidity, the current surplus is enough of a challenge. Governor Shaktikanta Das said, “‘we do realise as we are approaching the shore, we don’t want to rock the boat because there is a life beyond the shore."

But a prolonged period of high liquidity surplus is a threat to financial stability, even during times of low growth. Banks have already begun fretting about the challenges in assessing credit risk of companies. Pricing of risky loans is becoming difficult as easy money has brought down interest rates to decadal lows. As such, the banking sector has ceased to be the main financier of the industry. 

There are enough signs that the unprecedented liquidity surplus which is currently 9-10 trillion, is feeding into asset prices. Low money market rates are pushing funds slowly into the equity market through IPO-financing. The central bank itself has indicated several times in the past how uncomfortable it is with stretched valuations in the equity market. Companies are borrowing from the bond market at low yields. Even as domestic liquidity muddles risk pricing here, liquidity globally is making things more complex, feeding into commodity prices worldwide. It is clear that Indians are paying the price of this global commodity price surge through inflation. As such, the economic recovery which is desirable would have its own contribution to inflation. 

“We maintain that India is on a path of an inflationary recovery – while the cyclical growth recovery is ongoing, upside risks to inflation have further risen, especially with the latest surge in commodity prices," said Aurodeep Nandi, India economist & vice president at Nomura in an email.

Bond markets were understandably miffed with the end of the GSAP but the reaction to the policy has been mostly muted. The assurances that withdrawal would be gradual may have mollified markets but it remains to be seen whether the RBI can keep up with its baby steps.

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