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As signs grow of India’s economy emerging from its covid slump, our central bank should craft—or declare—a plan for the gradual withdrawal of its extraordinary stimulus to keep us going in the crisis. The chief policy rate of the Reserve Bank of India (RBI), the so-called repo rate at which it lends commercial banks money via overnight bond-repurchase deals, need not be raised above 4% for some time yet, given the fragility of our recovery and uncertainty of covid. But it has various other devices to manage monetary conditions, and excess money will soon have to start being sponged up. In theory, unless productive capacity keeps up, a sustained surplus can inflate retail prices. Inflationary pressure has eased a bit, lately, but moderation ahead cannot be counted upon, especially if demand strengthens from here on. An extended glut of cash entails other risks, too, such as a trail of mispriced loans and diversions of cheap money for dicey gambles, which could cause other forms of trouble ahead. This was a major lesson of the past decade. Today, our repo rate is below inflation. This policy is far from normal and we must not delay normalization. It just needs to be calibrated well so that it isn’t jerky.

As RBI reveals its latest policy on Friday, it may be too early to expect a shift in its stance from “accommodative" to neutral. But it could still squeeze its liquidity corridor by raising its reverse repo rate to soak up some cash. Our surplus is estimated in a range of 10-12 trillion, including government cash balances. This has pushed interbank call-money rates even below RBI’s reverse repo rate of 3.35%, the rate at which lenders park sums with it that they have no better use of. At times of low credit offtake with high liquidity whipping around chiefly among financiers, this rate tends to act as the country’s base price of money. Reducing the gap between the repo and reverse repo rates would imply action aimed at relatively instant efficacy and also signal RBI’s intent. Meanwhile, special windows for sector-specific infusions of money could perhaps be allowed to lapse. A major facility, renewed this August, will expire at the end of this year. As for RBI’s promise of bond-buying under G-SAP, its big-budget government securities acquisition programme could slowly be wound down. Of course, it can also be used to twist the yield curve of those bonds, done by selling short-term paper to reduce market prices at one end while buying longer-term paper to lift prices at the other. Any move made to absorb extra liquidity, though, may cheer up bond investors and reduce RBI’s very need to intervene.

Increased intervention on the external front, though, may be unavoidable as the US Federal Reserve tapers its own outsized covid response. The Fed has already initiated moves to get its bloated balance sheet back into reasonable shape and its policy of ultra-easy money can now be said to have an end in sight. As interest rate differentials affect global capital flows, with higher returns on dollar assets expected to result in outflows from India, RBI could insure us against hard bouts of volatility by staying ahead of—or at least in step with—the Fed’s policy reversal path. While a clock has been set ticking by this, our approach should be guided largely by the domestic scenario. If Indian output is on its way back up to 2019-20’s level this fiscal year after last year’s big covid crunch, leaving too much idle money around could return at some point to haunt us.

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