The latest data on Thursday show no respite for the central bank, with retail prices surging 7.61% in October, against the 7.31% estimated by economists. Inflation has remained above RBI’s 6% upper limit for seven successive months, though it has kept arguing that the pressure will ease.
Varma, a professor of finance
at the Indian Institute of Management, isn’t convinced.
He was the sole dissenter last month, when the RBI
kept rates unchanged and said accommodative policies would extend into the next fiscal year. Varma contended that the stance on lower-for-longer rates should not be a decisive one.
One of the hallmarks of a credible inflation-targeting regime is a substantial compression of the inflation risk premium, and the steep curve indicates doubts about RBI’s guidance, Varma was quoted as saying in the meeting minutes.
At the heart of the dispute is an interpretation of why the term premium -- the difference between short and long-term yields -- have stayed elevated. From July 2019 to August 2020, the gap between the policy rate and the 10-year bond yield increased 150 basis points to 215 basis points.
It’s now at 189 basis points, with the repurchase rate at 4% and the 10-year yield at 5.89%.
Liquidity, not inflation
For Patra, who co-wrote a paper with Harendra Behera and Joice John in the central bank’s November bulletin, the term premium is most closely associated with liquidity conditions.
Analysis shows that the bond market is backward-looking in its inflation view and adapts to prints that are one-month old, he said. Empirical analysis between January 2006 to September 2020 suggests that global uncertainty and liquidity are the main drivers of the term premium in India, he said.
“With interest rates at or the near-zero lower bound in several advanced economies, whether real or nominal, monetary policy that seeks to compress the term premium and influence the long-term interest rates more directly takes a step into the unknown,” Patra and his co-authors wrote.
spokesperson and Varma didn’t respond to emailed requests for comment.