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The Reserve Bank of India (RBI) on Friday stayed broadly on the expected course, continuing its focus on supporting growth through an easy-money policy with a watch on inflation, but it gave itself space to enlarge measures to sponge up some excess liquidity. The monetary policy committee (MPC) decided unanimously to keep the repo rate, or the rate at which it lends short-term funds to banks, unchanged at 4%, and the reverse repo rate, or the interest it pays banks for parking their surplus funds with it, at 3.35%. Also, its “accommodative" policy stance stays, with a 5:1 vote by MPC members in its favour.

With India’s economic growth showing signs of gaining momentum, RBI understandably does not want to take any action that could get in the way of a recovery in 2021-22 from our covid contraction last year. Freight and cargo movement, GST collections, electricity generation, cement production and a manufacturing bump-up all pointed to a revival of commercial activity, as covid infections stay subdued and vaccination coverage expands. Uncertainties, however, still remain. RBI retained its gross domestic product forecast for 2021-22 at 9.5%. Though it lowered the forecast for inflation this fiscal year to 5.3% from 5.7%, rising energy and commodity prices globally could yet exert upward pressure on general prices. 

Despite RBI’s generous money supply for lending purposes, credit demand has not been strong, private investment has been held back by weak consumption, and asset-price inflation has been a cause of some worry. With liquidity kept in such dramatic surplus for so long, a build-up of risks both obvious and hidden was inevitable. To limit these, the central bank must normalize its policy support. RBI’s moves to do this include a suspension of large bond purchases under its government securities acquisition programme, which could simply be turned into an ‘operation twist’ device for yield-curve management, and a potential step-up of its variable rate reverse repo (VRRR) auctions, which are a way to absorb idle cash from banks at rates typically higher than its reverse repo rate. RBI has put out a calendar for VRRR bond auctions and the cash to be withdrawn through these is significant. Yet, its reluctance to raise its reverse repo rate says something about how gingerly RBI is proceeding. According to governor Shaktikanta Das, a reversal of its support measures must be gradual, calibrated and non-disruptive. True. But as an institution, it must watch out for what lies over the distant horizon as well, not just the near-term impact of its policy. Extended phases of extraordinarily cheap money can have consequences that are not immediately apparent. Unless our recovery is far more fragile than made out to be, RBI should consider moving faster towards monetary normalcy. Lending money at rates lower than inflation, even if only to lenders, is not normal. It amounts to paying borrowers to borrow.

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