Home / Opinion / Columns /  What keeps RBI’s Shaktikanta Das awake at night?

Body language readers would have had a fun day observing Reserve Bank of India (RBI) Governor Shaktikanta Das fielding questions during the post monetary policy press conference on 8 April 2022. So would connoisseurs of governor-speak, specialists who have made it their life’s mission to parse every nuance expressed by central bank governors. Just when you thought that central bank chiefs had finally abandoned their traditional proclivity for discursive replies, Governor Das dragged central bank communication back to old normal.

Why restrains Governor Das from using plain-speak? The short answer could be that he doesn’t want to either send shock-waves through markets, mainly bond markets, or contribute to public expectations about higher future inflation which have a sort of self-fulfilling quality; either of the alternatives could upset the central bank’s desire to recalibrate expectations in an “orderly" manner. Looking at the language of the past few policy meetings, it would seem Das has been preparing stakeholders for some hard decisions that have now become inevitable. The introduction of a standing deposit facility (SDF) that was recommended by the Urjit Patel committee in 2014 and enabled through an amendment to the Reserve Bank of India Act in the Finance Bill of 2018, is RBI’s way of saying ‘we are raising rates’ without actually saying it.

Here is why. At a time of excess liquidity and accommodative policies, the reverse repo rate had become the operating benchmark. One option was to raise it from the current 3.35% to 3.75%; but it would have been seen as taking a sledgehammer to inflation, rudely interrupting RBI’s delicate inflation-growth dance. The next best option was to pluck out an instrument that had been warming the bench since 2018, brand it at 3.75%, and insert it into the wide 65-basis-points gap between the repo and reverse repo rates. Consequently, banks will now prefer to earn 3.75% via the new SDF for their surplus liquidity, rather than the 3.35% fixed reverse repo rate.

Markets got the message: the benchmark 10-year government security closed Friday’s trading at 7.12%, markedly up from Thursday’s close of 6.92%. However, the transmission mechanism from here to final lending and deposit rates is yet unclear and may have to wait for more decisive rate action from RBI; the street consensus suggests that is likely to be sometime between October 2022 and March 2023.

The central bank has been trying to recalibrate interest rate and liquidity expectations through its slow drum-beat on variable rate reverse repos (VRRR). After introducing longer-maturity VRRRs in the August 2021 policy as part of its liquidity rebalancing strategy, Das finally cranked up the pace in October 2021, with the volumes accepted under 14-day VRRR auctions moving up to 6 trillion for the fortnight beginning 3 December. And then began the final countdown:

· During the February 2022 policy meeting, Governor Das conceded the VRRR impact on rates: “Reflecting the migration of surplus liquidity from the overnight window to longer tenors, the effective reverse repo rate—the weighted average rate of the fixed rate reverse repo and the VRRRs of longer maturity—increased from 3.37% as at end-August 2021 to 3.87% as on February 4, 2022."

And finally on 8 April, he said: “…the interest rate for around 80% of the total liquidity absorbed under the [Liquidity Adjustment Facility] during Q4:2021-22 has firmed up close to the policy repo rate due to the rebalancing of liquidity through VRRR auctions." The policy repo rate is 4%.

There you have it, central banking through ambiguity and allusion, signalling that it’s perhaps time to start reconciling ourselves to higher rates and lower liquidity. Think of this as the semi-final, where, instead of going for the jugular through a benchmark rate increase, RBI has instead brought in the SDF. RBI’s monetary policy has also alluded to three other changes: inflation control preceding growth concerns in the sequence of priorities, withdrawal of surplus liquidity (around 8.5 trillion) over a multi-year time frame, and remaining “accommodative while focusing on withdrawal of accommodation".

RBI’s circular-speak might be legitimate on two counts. One, going for the bazooka treatment, as many had demanded, might have thwarted the economy’s incipient growth impulses. Two, it might have hardened inflationary expectations among firms and households and thereby made RBI’s task of inflation control even more difficult. The latest RBI survey on inflation expectations reveals that an overwhelming majority of households see the inflation rate climbing over the next 12 months. Rushing in with a rate action might have put immediate upward pressure on prices. But RBI still needs to be ready because inflation crossed the 6% marker in January-March and projection put it at 6.3% during April-June; and, even though RBI hopes the inflation rate will slacken to 5.8% in July-September, it could easily be pushed over 6%. Three consecutive quarters of breaching 6% has consequences. When asked about this eventuality, Das’s body language betrayed a certain anxiety, given the extraordinary number of moving parts—geopolitics, broken supply chains, oil prices—in play. RBI will therefore need to take action at some point; but it will be like landing the world’s largest aircraft, the Antonov An-225 Mirya, in the middle of a squall. Timing will be crucial here.

Rajrishi Singhal is a policy consultant, journalist and author. His Twitter handle is @rajrishisinghal.

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