RBI has just started a gradual liquidity reversal process
An upward turnaround in the GDP outlook was expected, but the RBI has retained the 9.5 per cent forecast. It is optimistic on investment recovery as well as the services sector. This is significant as the CMIE data on investments was not very positive for the first half of the year. The opening up of the economy after a nationwide lockdown to slow the coronavirus has finally covered the services sector. Interestingly, due to last year’s base effect, the quarterly growth rate for the year will decline from 7.9 percent in Q2 to 6.8 percent in Q3 to 6.1 percent in Q4. These statistical effects should not be interpreted as slowing down growth.
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Inflation forecast has come down from 5.7 per cent on expected lines to 5.3 per cent. The interesting thing here is that the quarterly inflation rate will come down from 5.1 per cent in Q2 to 4.5 per cent in Q3, but will rise to 5.8 per cent in Q4. Therefore, this means that the base effect will eventually fade away with the rise in prices. The RBI has rightly said here that two oils – edible and crude – will be the main risk this year going forward. This is probably the biggest risk to the economy as it affects input prices and ultimately growth.
The important message that was awaited was that the RBI was focusing on liquidity. It is important to reiterate here that RBI believes in gradualism. To regulate liquidity, RBI will not conduct any more GSAP auctions but will continue with OMOs and Operation Twist exclusively to regulate market yields. This is a positive move as it ensures that there is no increase in liquidity but returns remain regulated.
RBI will now be very aggressive in auctioning the V3R-Variable Reverse Repo Rate for 14 days which will help absorb excess liquidity in the system. RBI has rightly emphasized that V3R can also be called as Voluntary Reverse Repo Rate Auction as it aims to allow banks to keep their surplus money which is close to Rs 10 lakh crore in these auctions today and Earns more than 3.35 percent. So a calendar has been drawn up to December, absorbing progressively more liquidity from the system starting from Rs 4 trillion to Rs 6 trillion. This again is the ideal way to go about the absorption process.
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The final message – which is important – is to be taken that the RBI has just started the reverse process, but it is going to happen very slowly. The market will not be shocked by the release of the calendar. By assuring the market that RBI will use OMOs and Operation Twist at any point in time, it has reassured the market on the yield curve. Ideally there should be no reaction in the market. The 10-year bond has gone up from 6.27 per cent to 6.28 per cent, but perhaps we should not read too much into it.
(Madan Sabnavis is an independent economist. Views expressed are his own.)
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