Home >Opinion >Views >RBI’s policy challenge in this haze of uncertainty

When the path ahead looks hazy, it is often advisable to stay put and let the air clear up, rather than risk an accident. That is what the Reserve Bank of India (RBI) seems to have done. On Wednesday, our central bank left its repo rate, its lending rate for banks, unchanged at 4%. It also held its reverse repo rate, at which it absorbs their excess funds, steady at 3.35%. This affirmation of easy money was no surprise. However, it also retained its growth projection for our economy in 2021-22 at 10.5%, though RBI governor Shaktikanta Das did admit a rise in uncertainty over our prospects this year. As far as forecasts go, RBI made a slight shift in how it expects inflation to pan out over the next few quarters, with the headline figure for this measure still projected to stay safely under its tolerance limit of 6% this fiscal year. Taken in isolation, these numbers could have had us looking forward to a new fiscal year with a mix of relief and optimism. But they were received impassively—for good reason. Given the time lags of RBI’s data inputs, it may not have been able to take into account the riddles posed by a sudden surge of covid infections in India. Partial lockdowns have made a comeback in key industrial states over the past week and commercial activity is sure to suffer.

Thankfully, inflation has stayed within RBI’s target range, lately, which has allowed it to keep its policy highly accommodative, even enhance its bond-buying plans and extend special on-tap liquidity provision for another six months. Our near-term price risks appear more or less balanced, with a commodity uptrend offset to an extent by some lowering of taxes on petroleum products. By RBI’s estimate, after averaging a likely 5% in the three months till 31 March, retail inflation will edge up to 5.2% in the first half of 2021-22, before it eases to 4.4% in the third quarter and then rises to 5.1% in the last. Yet, this seems to assume that extra money pumped into our economy will not come to inflate retail prices, covid will not disrupt supplies, our external scenario will stay benign, and we will have a normal monsoon. A nasty turn on any of these factors might threaten that outlook. For now, RBI seems confident of its control of the yield curve on government bonds, despite post-budget market signals of investors seeking higher returns on longer-tenure paper to compensate for inflation risks. In support of its wider effort to keep yields down and the government’s cost of borrowing low, which is vital to India’s debt sustainability, RBI announced a new programme of bond purchases in the secondary market. Under this, it will specify upfront an outlay for bond buybacks in a given period. For the current quarter, it has set a target of 1 trillion. This will be in addition to its usual market operations to manage liquidity conditions. While such an exercise will surely ease upward pressure on yields in the short run, bond investors would remain wary of the eventual inflationary impact of a potentially expanded RBI balance sheet.

Our central bank has done well against rather trying circumstances ever since the covid crisis hit, and its latest moves can hardly be faulted, now that fiscal dominance is back in a big way. The frailties of our economic recovery do not allow a withdrawal of its support measures at this juncture. But it must keep watch of threats to price stability.

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