ANALYSIS: RBI finds a way to wean markets off liquidity ‘Chakrayvuh’

NEW DELHI: In 2013, when the then Governor D Subbarao left the reins of the Reserve Bank of India to his successor Raghuram Rajan, his advice to the new incumbent was to be an ‘Arjun’ rather than an ‘Abhimanyu,’ who succumbed to the ‘Chakrayvuh’ in his endeavour to win the epic battle in the Mahabharat.

The current RBI Governor, Shakikanta Das, would not blamed for feeling that he is caught in a similar ‘Charkayuvh’ as he has just too many battles to fight at this moment.

On Friday, Das began his monetary policy statement with what felt like almost a note of finality from a man who has had to steer the economy through what is possibly its biggest crisis since the balance of payments predicament of the early 1990s – the Covid-19 pandemic.

“This is my 12th statement since the onset of the pandemic. Of these, two statements were outside the Monetary Policy Committee (MPC) cycle – one in April 2020 at the outbreak of the Covid-19 crisis and the other in May 2021 at the peak of the second wave.”

It is important to note here that Das’ scheduled three-year term ends in December 2021.

But now, to get to the roots of his predicament: How does one wean the markets off the monetary policy largesse when the crisis ends as it would inevitably do.

Fresh Covid-19 infections in India are now rapidly declining as a large portion of the country has been vaccinated. Of course, the onset of the festive season could be a catalyst for a third wave, but RBI has to work with data in hand.

As Das himself acknowledged, high-frequency indicators suggest India’s economy is now gaining strength.

WHAT SHOULD MARKETS LOOK FOR?
A reversal of an ultra-loose monetary policy can take years, and as the experience of the latter stages of the UPA government showed, it can also feed terribly into inflation.

Das, on Friday, tried his best to strike a balance by not raising the reverse repo rate – currently the operative cost of overnight funds for banks – while at the same time signalling the central bank’s intention to mop up the deluge of liquidity unleashed amid the Covid crisis.

An oft-repeated phrase in the post-policy press conference was the “price of money”. And if one goes by that, the central bank is definitely looking to tighten the liquidity spigot.

Lest one forgets, crude oil prices are currently near multi-year highs, while the US Federal Reserve and a slew of other central banks are talking of tighter monetary policy.

Ironically, the cutoff rate at today’s variable rate reverse repo auction was at 3.99% per cent, a shade below the benchmark policy repo rate of 4.00%. Banks have already expressed to RBI that a hike in the reverse repo rate would provide more profitable opportunities to park idle funds.

Das on Friday, in what was probably the first time ever for an RBI Governor, addressed the concerns regarding profit margins raised by a particular bank. Of course, one cannot ignore the fact that these concerns were raised by the country’s largest lender, State Bank of India.

What Das has done, without raising any hackles or creating headlines, is starting the difficult process of normalisation.

The size of variable rate reverse repos has been raised from Rs 2 lakh crore to Rs 6 lakh crore in tranches and Das himself said that the tenures could also be increased from 14 days to 28 days. Essentially, the funds moving out are going up the term curve.

Perhaps more importantly, Das on Friday said there was no requirement of a fresh round of bond purchases under the ‘Government Securities Acquisition Programme’ (GSAP), a statement that sent yield on the 10-year benchmark government bond yield shoot up to a near two-year high.

Das’ hands are tied: liquidity is too huge to afford fresh accretion through upfront committed bond purchases.

Another way of looking at this is that RBI is permitting bond yields to rise, as they must in a rising interest rate scenario.

At the current moment, the talk is only about reverse repo operations. But if growth actually picks up — and government revenues improve — the next step could be open market sale of government bonds as the liquidity surplus right now is at record highs.

The equity market shrugged off the increased quantum of funds to be withdrawn from the banking system, but if the price of money were to go up, equity multiples (based on risk-free sovereign interest rates) could also see a correction.

Sometimes it is safer to say nothing but do something. Governor Das has an unenviable job, but one hopes that he will navigate his way through the Chakrayvuh well.

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