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By KVS Manian
The Reserve Bank of India (RBI) has clearly kept its ears to the ground in framing the last monetary policy. The surge in Covid-19 cases, leading to a seemingly vicious second wave, has definitely pushed the recovery trajectory by a quarter, if not two.
The pace of the Covid-19 vaccination has been slower than anticipated, adding to the worries on the time frame to get a control over the pandemic. Just now, in the most optimistic scenario, this looks like a 9-10 month vaccination programme to reach the thresholds of comfort. I am sure the government is thinking about speeding up the delivery mechanisms, as also ensuring optimum supply of vaccines itself. So, over the next few months, selective lockdowns/locational disruptions and other constraints will continue. This will lead to some demand disruptions as well as supply disruptions.
All this is bound to have an adverse impact on the economy, with some downside risk to the growth projections we had expected, even a month ago.
In such a scenario, that the RBI stance will be more accommodative and supportive of growth follows quite naturally. As all the countries attempt to do this over the next 12 months, we will see significant difference in the quality of execution amongst them.
Hopefully, India will be one of the countries that will emerge from this year with a strong tailwind ready to launch into a strong positive growth cycle.
Like most other central banks across the world, RBI is also clearly prioritising growth over incipient inflation worries. However, this remains a risk over the period of this financial year. While the headline inflation looks to be under control, the saviour has been the inflation in food prices, and core inflation numbers are already flirting with 6%. The risk to inflation is coming in a complicated manner, both from supply-side constraints in some areas and from demand-side pressures in others. This balancing act between supporting growth and curbing inflation is going to be the key challenge of the central bank this year.
The bond markets were very pleased with the announcement of the Rs 1 lakh crore open market operation (OMO) programme (christened as G-SAP, or the G-Sec Acquisition Programme) for the first quarter of FY22. It was precisely what the doctor ordered. This has cooled the yields over the long end of the curve. Through the variable reverse repo, RBI will also manage the lower end of the curve suitably. This may lead to some increase in yields in the short end, flattening the yield curve. The liquidity in the system will continue to be good, and with the above developments, the expectations of rise in policy rates over this year have significantly receded till late this financial year.
It will be interesting to see how the rupee reacts in the coming months. Global liquidity leading to strong flows into the Indian equity markets has helped bolster the rupee until now. Purportedly, RBI’s announcement of bond purchases and unwinding of positions by traders, who were already nervous due to the emerging Covid-19 second wave data, led to a fall in the value of the rupee. However, in the medium term, signals from the US and European markets on economic recovery and interest rates will be a more important factor. Just now, the US Treasury as well as European central banks seem quite determined to keep liquidity high and bond yields low, almost challenging the bond dealers to trade against them. Given these, the flow into attractive emerging markets is likely to continue, keeping the rupee reasonably stable.
The not-so-great news in all this is that the likely economic disruptions, caused by the next wave of Covid-19, could mute credit growth at a juncture when it was just showing green shoots of recovery. Asset quality issues in the financial sector could re-emerge. Coordinated steps by both the government and RBI through the last year helped ensure flow of credit and financial support to the segments in the economy that were the most susceptible, such as the MSMEs and other Covid-19-impacted sectors, and helped these segments tide through the crisis. Going forward, RBI and the government have to work towards a calibrated and smooth exit from this situation.
Another important announcement from RBI was that of permitting fintech companies to join the digital payment systems of the central bank. This is a progressive step, and will speed up digital adoption in financial transactions. India’s progress in this direction has been particularly noteworthy, and this announcement has signalled RBI’s continued and proactive focus in this area.
Overall, the policy is in sync with the times and recognises the need to navigate this uncertain period with an open mind.
The author is whole-time director and member of Group Management Council at Kotak Mahindra Bank. Views are personal