RBI is likely to stay in Liquidity Absorption Mode as reported by the Deputy Governor Michael Patra
The RBI has made its decision to stay in Liquidity Absorption Mode and the Variable Reverse Repo Rate (VRRR) must not be interpreted as a signal for withdrawal of liquidity or an ease in interest rates, mentioned Deputy Governor Michael Patra.
“Signals of the latter will be conveyed through the stance that is articulated by the MPC (Monetary Policy Committee) in its future resolutions. We don’t like tantrums; we like tepid and transparent transitions – glide paths rather than crash landings,” Patra added while speaking at the Confederation of Indian Industry’s (CII) financial markets summit.
He noted that the essence of flexible inflation targeting is to protect growth by lowering the sacrifice of output which is the “price” of price stability. In India, it is achieved by 5 specific features, which include a dual mandate, achievement of the target over a period of time, an inflation target defined in averages rather than as a point, a reasonably wide tolerance band around the target and failure being defined as three consecutive quarters of deviation of inflation apart from the tolerance band.
In May and June, Inflation surpassed the upper tolerance limit. With the cost push pressures impacting core inflation and its expectations, the MPC’s dilemma became sharper because firms showed evidence of some betterment or some improvement in pricing power and the base of inflation was shifting.
Reportedly Patra added, “Time will tell if the call is true. Data arrivals vindicate the MPC’s stance, with inflation having moderated into the tolerance band, and growth in the first quarter in almost perfect alignment with the RBI’s forecast.”
Supporting the decision made by the RBI to keep the reverse repo rate at 3.35 per cent and the repo rate at 4 per cent. In normal times, “the reverse repo rate is mechanistically linked to the repo rate by a fixed margin, as is the Marginal Standing Facility (MSF) rate. Pandemic times are, however, drastically different and call for out-of-the-box responses. This is accentuated by the fact that the credit channel of transmission broke down because of muted demand and risk aversion, and the RBI decided to operate through other segments of the financial markets to keep the lifeblood of finance flowing,” he added to the report.
Patra said that the suggestion of the repo rate strategy came from an external member of the MPC and the market participants also gave the RBI similar feedback in pre-policy consultations. “In effect, the RBI followed this counsel and the written resolutions of the MPC not just in letter, but also in spirit. By no means is the asymmetric corridor cast in stone. As normalcy returns, markets will return to regular timings,” Patra concluded.