Opinion
Rate moves unlikely; time for RBI to step up liquidity support
Summary
- There may not be any rate action from the MPC in August, and a few more months. More importantly, one feels that the case for stepping up the pace and quantum of primary liquidity infusion by the RBI has become materially stronger in recent months.
Globally, monetary policy is at an interesting crossroads. In contrast to rising interest rates during 2022 and 2023, central banks of several developed and emerging economies have lowered policy rates of late (e.g., UK, euro zone, Canada, Sweden, Switzerland, China, Brazil), some have even hiked (e.g., Japan, Russia, Indonesia, Egypt), while a large number of countries maintained status quo during 2024 (e.g., US, Norway, Australia, New Zealand, India, South Africa).
For an overwhelmingly large number of central banks which have kept policy rates unaltered, the next move is widely believed to be towards easing, albeit with considerable uncertainties and divergence in expectations about timing, pace and quantum of such rate cuts.
RBI’s bias to err on the side of caution
Despite challenging global headwinds, India’s broad macro backdrop remains enviably resilient with decent growth, moderate inflation, lower fiscal and current account deficits, strong FII inflows and a stable rupee. Such favourable macro situation imposes no pressure whatsoever on monetary policy in either direction, and, thus, offers a wider spectrum of choices and discretion for the central bank.
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Indeed, two of the external members of the monetary policy committee (MPC) strongly argued and voted in favour of a rate cut (and a “neutral" stance) in June. However, communication from the RBI top management has categorically highlighted the central bank’s commitment to steadfastly focus on the last mile of disinflation and, thus, their bias to err on the side of caution as regards to rate action.
Against that backdrop, one expects the status quo on the repo rate to continue in the August meeting with no change in the voting pattern. This meeting is the last one for the three external MPC members, including two members who voted for a cut in June. Three new external members will join the MPC beginning October.
The case for stepping up liquidity infusion
In sync with the policy stance of “withdrawal of accommodation", RBI absorbed large quantum of liquidity from the banking system since the summer of 2022 – banking system liquidity, which was at an average daily surplus of ₹4.6 trillion during April-June of 2022, turned into an average daily deficit of ₹0.6 trillion during the similar period of 2024.
Growth in reserve money – the measure of primary liquidity infusion by the central bank into the banking system – also fell sharply during this period. Against the compounded annual growth rate (CAGR) of over 15% during five years up to mid-2022, reserve money recorded a CAGR of merely around 7% over the next two years till date. The deceleration in reserve money was noticeable from May 2022, but accentuated even sharply since the next summer, reflecting the effects of withdrawal of ₹2000 banknotes by RBI in May 2023.
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Growth in deposits in the Indian banking system lagged credit growth now for an unusually long 28 straight months. CAGR of bank credit over this period, at around 14.5%, was in fact softer than average bank credit growth rate of around 16.5% for the 20 years prior to this phase. However, systemic liquidity pressure accentuated as CAGR of deposits since April 2022, at about 11%, was way lower than its long-term trend (say, that of about 14.5% in the previous 20 years), underscoring the need for larger quantum of primary liquidity support from the RBI.
The recent trend of BoP surplus with capital inflows materially exceeding current account deficit continues to offer the RBI room for faster reserve money growth via purchase of foreign exchange. Against a complicated global macro and geopolitical backdrop, a faster accumulation of forex reserves should be seen as a prudent step for rainy days, especially given the recent inclusion of Indian government bonds into global bond indices. Also, the use of variable rate reverse repos (VRRR) will likely pre-empt the possibility of any sudden fall in the call money rate.
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In sum, there may not be any rate action from the MPC in August (and a few more months), while one sees merit in changing the monetary policy stance to “neutral". More importantly, one feels that the case for stepping up the pace and quantum of primary liquidity infusion by the RBI has become materially stronger in recent months.
The author is chief economist Bandhan Bank. The author thanks Sudarshan Bhattacharjee and Gaurav Mukherjee for assistance. Views are personal.
