By Anjan Roy
In the grim context of a second wave of covid infections spreading throughout the country and nervous sense of foreboding, Reserve Bank’s latest monetary policy is admirably anchored in pragmatic optimism. This is good for a struggling economy and hopefully should be borne out by events.
The latest report of the Reserve Bank’s monetary policy committee and the subsequent policy statement from the governor, Shaktikanta Das, are significant on three counts.
First, the RBI seems to have swung round to a view that the inflationary situation could be contained within benign levels and thus there was a little leeway for policy making. The flexible inflation targeting regime of the last four years is believed to have achieved a kind of stability at the 4 per cent level and this is the average inflation level set for the next five years till March 2026.
For “CPI inflation is now projected at 5 per cent in Q4FY21 compared to 5.2 per cent earlier; 5.2 per cent in Q1FY22, 5.2 per cent in Q2, 4.4 per cent in Q3 and 5.1 per cent in Q4, with risks broadly balanced”. However, given the uncertainties with global oil prices as well as trends in food prices, how safe is such projections. One key action in price stabilization programme could be the non-monetary one; a political consensus on cutting some taxes.
As the major driver of prices, the food inflation would critically depend on the monsoon. The silver lining is that last year’s bumper food production should help carry on the trend towards moderation. However, vegetables prices, which are emerging as major influence on the general price line due changing habits of consumption, are still prone to sharp fluctuations due mainly to the dearth of handing chains,
Secondly, on overall growth situation, RBI has maintained its projections at 10.5 per cent for 2021-22. But there could be some cause for worry, maybe, in view of the second wave of covid infection sweeping across large swathes of the country. The infections have touched major centres of economic activity and thus could leave a deeper imprint on the growth prospects in the coming quarters.
The hope is that with rapid vaccination, it should be possible to check the spread and no fresh lock-downs would be necessary. But once again it is better to keep fingers crossed as this infection is turning out to be strangely defiant with mutants strains appearing in the country. One only hopes that the present crop of vaccines should prove effective against variants.
Appropriately, taking the uncertainties into its feedback loop in the current context, RBI has moved over to, what most of the commentators are saying from a time bound stance of the monetary policy to a “status” based policy formulation. This implies in effect to anchor the RBI policy formulation to the data feedback coming to it rather than a committed time-bound projection of policy stance.
This is possibly good in the current situation. We are going through tumultuous times and there are unforeseen developments. Until a month back, it had appeared that India had by and large tamed the covid infections and there were some self-congratulatory pronouncements as well. This had been rudely shaken with the fast and unanticipated spread of infections.
The third and most unexpected announcement from the RBI governor was that regarding a committed government bond purchase programme. This new initiative was like taking a leaf out of the copy book of the US Federal Reserve. The announcement has been variously described as a form of QE or quantitative easing, as pursued by the US and EU central banks.
Called G-SAP (government securities acquisition programme), this will involve Reserve Bank buying equivalent of Rs 1 lakh crore government securities from the secondary market in the first quarter of 2021-22. Presumably the purchase programme will be equally spread over the next year. This, presumably, will be over and above the traditional open market operations of the RBI under which it purchases or sells government securities as a tool of liquidity control.
The US Federal Reserve and European Central Bank had resorted to quantitate easing primarily to keep their economies humming along on the recovery path in the wake of the 2008 global financial meltdown. The QE had to be introduced as the central banks had ru out of all other instruments for interventions when their prevailing interest rates had plunged to negative territories in most countries. The supply of such money had given huge amounts of additional liquidities in the systems to keep up effective demand which had plumbed to unprecedented depths after widespread unemployment post 2008.
However, RBI’s G-SAP programme looks different in context and purpose. RBI is primarily thinking of buying up government securities in the secondary market to intervene and manage the bond yield curve. Bond yield depends on the supply and demand for bonds. It is expected that the union government would be obliged to borrow much large amounts in the forthcoming year to shore up its finances in the face of huge extra expenditure in the covid years.
The fiscal deficit is expected to jump up to over 5 per cent in the fiscal 2021 and hence with larger volumes of government securities flooding the market, the yield on them would have risen. Already, the system is flushed with liquidity and the public sector banks are holding close to Rs 5 lakh crore n excess government bond holding.
When more government binds flood in, who will buy them. These pressure will jack up the yield curve and thus overall pressure on interest rates will rise. RBI’c committed bond purchase programmes would to a large extent let the steam out and help stabilise yield on government bonds.
Once RBI stabilizes its G-SAP operations, this will have a calming influence on the financial markets and pricing of other financial products, which are set in reference to the government securities bond, will also reflect a kind of even temper. The move should be of critical importance now as financial markets are under severe stress and they need to be anchored more firmly. RBI has taken a bold and forward looking step. (IPA Service)