RBI keeps rates steady, economists predict tighter liquidity, higher rates by March ‘22

| Updated: August 6, 2021 2:43 pm

As expected, the Reserve Bank of India (RBI) on Friday announced to keep the benchmark interest unchanged, with an economic outlook on the status quo and an increase in inflation estimates for the year 2021-22. However, economists argued that the era of record-low interest rates is ending and sooner than expected interests are going to rise.

However, the biggest takeaway from the policy statement by the governor is that the RBI is preparing the country towards normalisation – from ample liquidity, record low-interest rates to higher rates and tight liquidity.

Meanwhile, the RBI projected India’s GDP to grow by 9.5%, with no change from its previous policy meeting. It estimates that the country’s economy to grow at 17.2% in 2022-23.

For inflation, the RBI maintained that price rise scenario in the county is due to temporary demand and supply factors. For the year 2021-22, the central bank projected consumer price inflation at 5.7%, a tad higher than the previous meet.

Liquidity Normalisation Starts

At the moment, there is huge liquidity in the monetary system. As per the data of reverse repo – the amount of money absorbed by RBI from the system every day – the total absorption through reverse repo surged from a daily average of Rs5.7 lakh crore in June to Rs6.8 lakh crore in July 2021 and further to Rs8.5 lakh crore on August 4.

To weed out excess liquidity in the system, just before the Covid19 pandemic hitting in India, RBI had announced a tool called 14-day Variable Rate Reverse Repo (VRRR). This was discontinued during the pandemic phase as the economy needed excess liquidity to ease the cash crunch at the banking, household and industry level. However, it has been reintroduced in January 2021. To further absorb the liquidity governor announced three more auctions of the VRRR.

“It has now been decided to conduct fortnightly VRRR auctions of Rs2.5 lakh crore on August 13, 2021; Rs3.0 lakh crore on August 27, 2021; Rs3.5 lakh crore on September 9, 2021; and Rs4.0 lakh crore on September 24, 2021,” Shaktikanta Das, the governor announced. He also added that regular reverse repo operations to absorb liquidity will continue on regular basis.

Interest Rates to Go Up

Allying with the fear of discontinuation of accommodative stance, the governor categorically denied market participants to not see VRRR measure as a change in policy. “These enhanced VRRR auctions should not be misread as a reversal of the accommodative policy stance,” he said.

“With economic recovery expected to gain momentum in the second half of this fiscal and inflation remaining elevated, we expect tightening down the road,” Dharmakirti Joshi, chief economist with Crisil said after the policy announcement.

“The transition from low-interest rates and easy financial conditions to post-pandemic normalcy can be a bumpy one. The RBI is trying to smoothen the process by gradually draining excess liquidity through variable reverse repo rate operations,” Joshi added.

Echoing similar views, senior economist with Kotak Mahindra Bank also said that journey towards liquidity normalisation and higher rates has started.

“We believe that the increased risks to inflation especially as the economic activity is picking up pace has prompted the MPC into taking liquidity normalization measures ahead of our expectations. We expect additional liquidity normalization measures like overnight VRRR, increased quantum of higher tenure VRRR in the months ahead before expecting a reverse repo rate hike in December,” Upasna Bhardwaj, Senior Economist at Kotak Mahindra Bank said.

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