RBI policy review: Amid focus on cash control, rate to remain unchanged

Reserve Bank of India
There is near unanimity that the six-member monetary policy committee of the Reserve Bank of India (RBI) would keep policy rates unchanged, but this being an annual policy, the event promises to discuss many issues that would set the stage for the next one year, including bad-debt resolution and liquidity management.

The repo rate is at 6.25 per cent now, while the RBI has changed its stance to 'neutral' from 'accommodative', indicating pause in a rate-cutting cycle. Core inflation, which is consumer price index (CPI) minus food and fuel, is sticky at around five per cent, even as the headline CPI has fallen below four per cent, well within the target of RBI. However, economists say uncertain monsoon can flare up prices and, therefore, the central bank would likely wait before deciding the way for rates to go. Meanwhile, the focus would be to continue to nudge banks to cut lending rates.

The most important issue that the economists would keep an eye on would be the central bank's take on the liquidity situation and measures to safeguard the RBI balance sheet should the huge amount of excess liquidity be parked with the central bank. The central bank has to mortgage an equivalent amount of bonds against the money that it receives in the reverse repo window. RBI has a bond holding of about Rs 7 lakh crore. Of this, a sizeable portion has to be kept as collateral against government cash balances and some more as a buffer. To ease this, the RBI governor Urjit Patel committee on monetary policy had suggested the creation of special deposit facility (SDF), which is a kind of non-collateralised liquidity parking instrument. Economists expect the central bank to spell out the creation of such an instrument in this policy. On a net basis, banks are parking more than Rs 3 lakh crore of their excess liquidity with the central bank. A month into demonetisation, banks had parked more than Rs 5 lakh crore of their excess liquidity with RBI, after which the central bank increased cash reserve requirement (CRR) on incremental deposits to 100 per cent, from the norm of four per cent. CRR is the portion of deposits banks have to maintain in cash with the central bank. SDF can solve this problem. 

“It would be interesting to see what RBI's take is on durable liquidity. If RBI spells out the creation of SDF, that would be one of the key points of the policy,” said Saugata Bhattacharya, chief economist at Axis Bank. Bhattacharya expects a prolonged pause in monetary policy and says much would depend on the outcome of the monsoon.

“Apart from existing conventional liquidity management tools, the government/RBI also appears to be considering the introduction of uncollateralised SDF operations. It would be interesting to see its operational mechanism in terms of rate setting and RBI's stance on variable reverse repo once SDF is in place,” said a Kotak Mahindra Bank report.

However, this being an annual policy, RBI's communication assumes significance.

“The annual policy meeting is critical in terms of setting up expectations based on forward-looking guidance, policy initiatives, and any initiatives on financial market developments. Since the stance has changed to 'neutral', communication strategy will be key for incremental rate transmission and development of future expectations,” said Soumyajit Niyogi, associate director, core analytical group, India Ratings & Research.

The monetary policy is expected to broadly give a direction to bad-debt situation of Indian banks. Economists also say that the growth-inflation dynamics have become more critical after the change in stance to neutral and therefore guidance on growth would be critical.

Besides, one more critical question on everyone's mind would be RBI's numbers on how much in old notes was returned to the central bank. All windows to return the old notes closed in March.

Key takeaways

* Near unanimity: that the monetary policy committee would keep policy rates unchanged on Wednesday

* Annual event: promises to discuss many issues including bad-debt resolution and liquidity management

* Repo rate: is 6.25% now, while the RBI has changed its stance to 'neutral' from 'accommodative'

* Core inflation: is sticky at around 5%, even as the headline CPI has fallen below 4%

* Economists say: uncertain monsoon can flare up prices. So RBI would likely wait before deciding the way for rates to go

* Special deposit facility: Economists expect creation of non-collateralised liquidity parking instrument in this policy

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