Fisc does heavy-lifting, up to RBI to ensure liquidity PDF Print E-mail
Friday, 05 February 2021 07:05
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Shobhana edit

Given the government has opted to do much of the heavy-lifting to pull the economy out of its slump, Reserve Bank of India (RBI) can now rest a little easier. After a year of shouldering the burden of kickstarting growth, the central bank is now expected to play a supporting role to ensure the recovery sustains. Its challenges now lie in ensuring interest rates don’t see too sharp a spike and that the exit from the accommodative liquidity situation is a smooth one. The fiscal deficits for both FY21 and FY22—even adjusting for subsidies becoming a part of the balance sheet—are fairly elevated and should trigger growth impulses. That is welcome, even if some of it is inflationary, because the recovery so far has been rather uneven. The high expenditure levels, at about 10.3% of GDP compared with 8% pre-Covid should take the pressure off RBI.

Nonetheless, RBI will continue to bat for growth worrying less about price pressures and is, therefore, unlikely to raise the repo rate from the current 4%. Fortunately, no runaway price increases are anticipated in the near term with the momentum, both in the food prices and core expected to be moderate. Inflation is expected to average around 4.5-5% in FY22, albeit above the MPC’s comfort level of 4%. Given a good chunk of government spending, this time around is in the form capex, price pressures are expected to kick in only with a lag. Again, while the government capex may have gone up by 27%, the total (including the CPSEs, etc) is up just 4%. Moreover, as economists have pointed out, there is also a fair bit of slack in the economy as seen in the dull momentum in core inflation. However, in the medium term, there could be inflationary pressures with global growth and trade expected to get a boost from the stimulus packages and commodity prices also rising. But until then, RBI will not worry too much about inflation.

Also, there is a need for the negative real policy rates to reverse because it could impact macroeconomic stability adversely. However, as Samiran Chakraborty economist at Citibank points out that right now the output gap is so wide that if monetary policy turns somewhat restrictive at a juncture when the fiscal stance is turning expansionary, the output gap could persist for longer and the macro situation could become harder to manage. For now, therefore, it is liquidity that RBI needs to manage to ensure the government’s enormous borrowing programme goes through; the gross mop-up of Rs 12 lakh crore in FY22—a net amount of Rs 9.2 lakh crore—and ahead of that, an extra Rs 80,000 crore in the current year. The government’s borrowing apart, interest rates need to remain affordable to support the nascent recovery and as such RBI shouldn’t be in a hurry to soak up liquidity. Governor Shaktikanta Das will want to reassure the bond markets that liquidity will not be drained out in a rush, it will be done gradually, and also that there will be enough signalling done through the OMOs, twists and cut-off yields on the auctions. There are also economists who feel RBI should consider only a staggered increase in the CRR, though an increase in the reverse repo rate, which is at a very low 3.35%, is possible soon. The repo, for now, stays put.


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