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ARCs are willing to offer flexibility to banks in terms of the structuring of the deals. RBI requires ARCs to make a minimum of 15% down payment to banks; ARCs are willing to strike all-cash deals. Photo: Aniruddha Chowdhury
ARCs are willing to offer flexibility to banks in terms of the structuring of the deals. RBI requires ARCs to make a minimum of 15% down payment to banks; ARCs are willing to strike all-cash deals. Photo: Aniruddha Chowdhury

RBI could cool its rate cut tool and bring everything else to good use

  • RBI still has room to cut rates this year and contraction could keep the rate pause temporary
  • Absorbing govt’s market borrowing could help RBI keep liquidity in surplus and yields in check

The Reserve Bank of India’s (RBI) monetary policy committee (MPC) with three new external members would meet in five days from now to vote on policy rates. Most economists are expecting a temporary pause on rate cuts given the rise in retail inflation.

To be sure, an inflation rate consistently above the flexible target of 2-6% for four months is enough for the MPC to sit tight. That said, the worry over inflation need not stretch out if the central bank’s expectations of ease in inflation come true. RBI still has room to cut policy rates this year, and an unprecedented economic contraction could keep the pause on rates temporary. “The current elevated level of inflation, which is well above RBI’s upper bound of 6%, suggests that the MPC will pause again in October. However, in view of more durable damage to growth versus a transitory shift in inflation, we expect 50 basis points in cumulative rate cuts in total, with the next 25 basis points to be delivered at the December policy meeting," wrote analysts at Nomura Financial Advisory and Securities India Ltd.

Juggling targets
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Juggling targets

But for RBI and market’s expectations of a fall in inflation to come true, there needs to be deft management of liquidity. Surplus liquidity courtesy of an accommodative policy stance should be enough to help economic recovery but avoid feeding into asset prices.

Here RBI faces its old trilemma of a current account surplus, an overvalued exchange rate and a precarious fiscal position in need of support. But there is also a supply-side shock at play from a pandemic. Sajjid Chinoy, chief India economist at JP Morgan, in a BloombergQuint column describes the Reserve Bank’s challenge as a quadrilemma.

Is there a way out? Economists believe that absorbing the government’s market borrowing would help RBI achieve its twin objective of keeping liquidity in a manageable surplus mode as well as a lid on market yields.

Rahul Bajoria, chief economist at Barclays Securities (India) Pvt. Ltd, believes the central bank still has enough room to pump in primary liquidity through bond purchases. “We noted that RBI must at least duplicate the actions it took during the global financial crisis," he wrote in a note. “To match the 2009-10 increase in reserve money, RBI may have to continue its purchases of government bonds, which would help ease financial conditions and also support the government’s record borrowing programme in the second half of the current fiscal year."

Even as it buys bonds, RBI will have to keep buying dollars as well, according to analysts at HSBC Securities and Capital Markets (India) Ltd.

So while the MPC would keep its arrow cocked on rate cuts, markets should expect RBI to use every policy instrument to juggle its various objectives until retail inflation behaves.

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