It is always difficult to write something different on the monetary policy when the whole world has covered it and markets have taken cognizance of the implications. While this is a status quo policy, the RBI’s thought processes with certain issues have been laid out extremely clearly.

First, and most importantly, the RBI is clearly against any strategy that can merely lead to short-term gains. Second, the RBI is satisfied with its type of liquidity management strategy and hence, has failed to provide any comfort to the market that had been clamouring for more open market operations (OMO) and had been arguing for an expansion in the RBI’s balance sheet. Third, even while keeping the monetary policy “accommodative”, given the inflation trajectory the RBI draws out at present, there is onlyvery small room for further easing of monetary policy.

The thought process of the Governor was adequately amplified in one of his speeches just a few days ahead of the policy at NCAER, New Delhi. He drew the example of Brazil and pointed out that there is an enormous cost of becoming an unstable economy, and this cost far outweighs the “small” growth benefits that can be obtained via “aggressive policies”.

Playing safe The moot point that the Governor was trying to make was that India “should be very careful about jeopardising our single most important strength during this period of global turmoil, macro-economic stability”. From the central bank’s perspective, this is extremely important in the context of the recent debate about the need for India to postpone the fiscal consolidation path for a second consecutive year.

According to the Governor’s assessment, the growth multipliers on government spending currently are small, implying that more spending will mostly hurt debt dynamics. This also has a crucial connection with the overall interest rate dynamics, including G-Sec yields.

This clearly signalled the RBI’s intent that monetary and fiscal policy needs to be adequately coordinated to provide the necessary policy enablers for the economy, while keeping in view the macro-stability perspective. In this context, the policy document clearly indicates the central bank’s expectations from the Budget, before it moves ahead with further monetary accommodation.

It says that the Budget needs to outline its structural reforms programme while controlling spending, and this will open up more space for monetary policy to support growth. Thus, one can expect the RBI to ease monetary policy only post-Budget, probably on the next policy date of April 5, if not earlier.

The second highlight was the clarity from the RBI with respect to its liquidity management measures, at the post-policy presser. The Governor pointed out that, for the moment, liquidity accommodation was adequate as the rates in the call and overnight money markets are in line with the policy rates.

While the RBI would stand ready to provide liquidity to the market via all available instruments, including OMOs, the choice of instrument would crucially depend on the assessment of long-term liquidity requirements against short-term requirements.

The RBI stands vindicated as the liquidity situation has currently eased out post-policy, with the government starting to spend again. Clearly, the signalling from the RBI is that it would use OMOs only to address structural liquidity gaps that might arise out of its FX asset sales.

Even hoping that the Budget satisfies the RBI with respect to both the quality and quantity aspects, the room for monetary easing might not be significant. The RBI’s next target for inflation is 5 per cent by end-March 2017 and the fan chart in the policy document expects an “inertial” trend in the months ahead. And this also does not factor in any impact on inflation from the 7th Pay Commission. With indicators pointing to continued delay in private investment cycle, additional repo rate cuts to the extent of only 25-50bp appear possible.

Reflective of market fears Finally, with respect to bond yields, long bond yields appear to be rising even when the RBI has maintained its accommodative policy stance.

But this in itself could be reflective of market fears of a significant supply of papers — Central, state and UDAY bonds. Initial estimates of IDFC Bank indicate a likely gross central borrowing of close to ₹6.4 trillion, a gross state borrowing of ₹3.4 trillion, amassing to a total of around ₹10 trillion. Hence, it could be difficult to visualise significant drop in bond yields, unless there is clarity from the Budget on fiscal consolidation.

The writer is Group Chief Economist, IDFC

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