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The MPC recognizes the need for wiggle room in uncertain times

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  • The committee’s nuanced forward guidance lends us hope even as RBI boosts its risky game of yield curve management
  • The MPC’s subtle shift in guidance makes space for inflation control, if need be. And while it wants an ‘orderly’ yield curve governed by fundamentals, the bond market can’t expect a level playing field

Monetary policy committees (MPCs) never have it easy. Macroeconomics abounds with unknown unknowns. And when, as with India’s present MPC, it has painted itself into a corner with definitive time-bound forward guidance, the task is that much harder.

In the event, Reserve Bank of India (RBI) governor Shaktikanta Das’s monetary policy statement on Wednesday, 7 April 2021, was mostly on expected lines. The decision to maintain status quo on policy rates and retain the central bank’s accommodative policy stance was virtually a given. With a second wave of covid upon us and an economic recovery far from certain, RBI’s rate-setting MPC could ill afford to rock the boat by changing its stance.

What it could, and did do, is announce a (welcome) shift in its forward guidance. Retaining its earlier forward guidance of February 2021 that “monetary policy will remain accommodative this fiscal and into the next fiscal" would have left RBI with little wiggle room, if needed.

If, for instance, inflation increased beyond the upper end of RBI’s target range of 2-6% on a durable basis, the bank would have been caught in a bind. Remember, the International Monetary Fund has already warned of rising inflationary pressures globally. More recently, Moody’s has termed India’s inflation “uncomfortably high".

The shift to a more nuanced stance, “Monetary policy will remain accommodative till the prospects of sustained recovery are well secured while closely monitoring the evolving outlook for inflation" is, therefore, very welcome. It is a recognition of the dangers of committing to a pre-determined, time-dependent path in a world of increasing uncertainty. In contrast, terms like “prospects of sustained recovery are well-secured" are open to much more varied interpretation, allowing RBI to make course corrections without losing credibility should the need arise.

Remember, RBI is not the mighty US Federal Reserve. Monetary policy in India, as in all emerging markets, is critically dependent on the actions of the Fed, the de facto global central bank. If the Fed were to tighten monetary policy earlier than anticipated, RBI would have no alternative but to do likewise. Or else risk a potentially destabilizing outflow of funds from the country.

Agreed, we are no longer as dependent on debt flows as in the past, and that makes us less vulnerable to sudden stops/reversals in foreign exchange flows. High forex reserves also give us more comfort. Nonetheless, it would be naïve to assume we are immune to any policy reversal by the Fed. Or that the Fed will look beyond its domestic compulsions (read: care about the consequences of its action on other economies) while framing policy.

For now, or at least till such time as the Fed continues to pump in dollars, RBI has the necessary elbow room to “do whatever it takes to support growth". In RBI’s eyes, ‘support’ means ensuring an “orderly evolution of the yield curve governed by fundamentals, as distinct from any specific level thereof". Does this mean RBI would henceforth desist from intervening in government securities auctions, at times going as far as calling off an auction altogether in a bid to keep rates artificially low? Not necessarily, governor Das was quick to clarify, at the post-policy press conference. He was responding to a question about RBI’s stance in future auctions if markets demand a higher yield than RBI is prepared to give. Would RBI, as the government’s loyal debt manager, be happy to concede?

The message is clear. Bond markets will have to make the best of a playing field that is far from level; where the rules of the game are framed, unilaterally, by RBI. At present, government securities (G-Sec) auctions are a bit like gully cricket. Just as the owner of the bat reserves the right to walk away with her bat when she’s unhappy at being declared out, RBI today reserves the right to reject all bids and cancel the auction rather than bow to market forces! This is a right it has ruthlessly exercised in recent bond auctions.

Bond markets, however, have something to cheer: RBI’s decision to operationalize a Secondary Market G-Sec Acquisition Programme (G-SAP). Under this programme, the central bank will commit upfront to a specific amount of open market purchases of G-Secs to ensure a stable and orderly evolution of the yield curve. The announcement of the quantum and timing of the purchase, 1 trillion in the first quarter of 2021-22 with the first purchase of 25,000 crore slated for 15April 2021, will provide bond markets some certainty, and to that extent, reduce volatility in yields.

Yield management is the name of the game. So, the bias in favour of borrowers (especially the biggest of them all, the Centre) continues. The hope is that low rates of interest rates will incentivize investment and thereby, growth. It is a different matter this has not happened during the past many months, even when real interest rates were negative.

Savers, it would seem, are best advised to fend for themselves. This is a dangerous game. Savings are the bedrock on which lending is done, and lasting damage to savings, especially household savings, could prove costly. At a time when household savings have already fallen precipitously, RBI, I dare say, is on a wing and a prayer.

Mythili Bhusnurmath is a senior journalist and a former central banker.

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