RBI must bat for growth, more measures to soak up liquidity may be announced on Feb 10

This week, the monetary policy committee (MPC) faces the difficult task of charting out the course for normalisation. The MPC meet is being held against the global backdrop of central banks, especially the US Fed, moving quickly to withdraw from their accommodative stances so as to rein in inflation. With crude oil prices soaring past the $90 mark and imported inflation seeping in, potential inflationary pressures would warrant a rise in rates in India too. However, at the same time, the growth recovery remains uneven; even if the latest wave of the pandemic hasn’t quite caused the kind of damage as the previous ones did, the recovery is clearly slowing. The services PMI, for instance, slipped to a 6-month low in January and services, as we know, form the biggest segment of the economy. Striking the right balance between curbing stubbornly high inflation and supporting growth will not be easy.

What will really put RBI in a fix, this time around, is the Centre’s large borrowing programme. The gross borrowing in FY23 could ultimately turn out to be lower than the budgeted `14.95 lakh crore. A smaller lower repayment bill, a lower than expected fiscal deficit in the current year on the back of better tax revenues and more cash carried over to the next year—that can be used to fund the deficit—could all help bring down the borrowings. Nonetheless, an amount of even, say, Rs 13.5 lakh crore, would be considered big at a time when both RBI support and banks appetite to invest in gilts are falling.

Despite the inflationary pressures, therefore, RBI can be expected to tighten monetary—by raising policy rates and draining liquidity, only gradually. So, at this point, the central bank is likely to leave the repo rate unchanged but raise the reverse repo rate by 25, or even 50, basis points and try and announce measures to soak up more liquidity. RBI has been gradually draining liquidity from the system. Had growth picked up as anticipated, RBI would have had the opportunity to temper inflationary expectations. However, going by the data for January, demand remains muted. Indeed, there is a good chance consumption demand will slow in the second half of FY23 after the pent-up demand is satiated. Right now, the trade-off between growth and inflation needs to be in favour of growth. Without the Centre’s big jump in the capex outlay—which is what has resulted in the high government borrowings—growth would be even slower and fewer jobs would be created. That then would keep consumption low for a longer time. To that end, the higher borrowings can be justified because the capex could help ‘crowd in’ private investment.

To be sure, inflationary pressures are strong. The December inflation print of 5.59% is within RBI’s glide path for inflation, below 5.7% by end-FY22; but it marks a five-month high in consumer prices, already quite high to begin with. Although RBI has been less than open to acknowledging that inflation is entrenched, the central bank appears to have become amenable to rising yields. At the same time, it has allowed auctions to devolve on primary dealers recently, refusing to give in to demands for better yields. The yield on the benchmark, which was 6.35% at the time of the December monetary policy announcement, is now nudging 7%. As many experts point out, it is possible the yield could soon hit 7.25%. No doubt, this will make borrowings costlier for the government, and loans for companies and individuals, a lot more expensive. But, right now, RBI needs to bat for growth.