Thoughts on Budget and monetary policy
Beyond hype, if the Budget creates a platform for growth, the RBI will have to change the policy’s stance, but that won’t happen — now or even in April
Beyond hype, if the Budget creates a platform for growth, the RBI will have to change the policy’s stance, but that won’t happen — now or even in April.
TAMAL BANDYOPADHYAY writes
Three days after the muchhyped Union Budget, the Reserve Bank of India (RBI) will announce its February monetary policy, the last for fiscal year 2021.
As the economy is in a recovery mode, a non-disruptive Budget is par for the course. The welfare measures should continue and, at the same time, it must explore ways to boost consumption to keep the momentum going. While no cut in income tax is warranted, excise duty on oil could be pared. Rising tax revenue will neutralise its impact on fiscal health.
One can expect steps to boost the speedy recovery of bad loans, which will strengthen the banking system and whet its appetite for lending. The RBI has already warned that the banks’ bad loans can almost double in an economy mauled by the pandemic.
Also, the Budget is likely to unveil a formula for rapid privatisation of public sector undertakings, which could include banks. Disinvestment of government stake in such entities will generate money that will help filling in fiscal deficit, which, going by most analyst estimates, could be around 5.5 per cent or even less in fiscal year 2022, down from a little over 7 per cent in the current year ending March 2021.
In sync with this estimate, the Centre’s gross borrowing for 2022 could be a little over ~10 trillion. It won’t be a headache for its merchant banker, the RBI, which is managing a much higher borrowing in the current year.
Of an estimated ~13.1 trillion government borrowing programme in 2021, around ~11.1 trillion had been raised till last week. Besides, the state governments have borrowed a little over ~6 trillion against an estimated ~8.5 trillion for the year. The Centre may refrain from raising the full amount as its cash balance kept with the RBI has been around ~3.3 trillion now. This means the government is not spending as much as it has committed to spend. This has been the case most of the time.
To the RBI’S credit, it has been a smooth sailing for such a hefty government borrowing without impacting the bond yields. It has been able to keep the cost of borrowing low for the government even as the buyers never lost interest. The 10-year yield has averaged 5.93 per cent during the fiscal year since April 2020. At the lowest end, the 91-day treasury bill averaged 3.32 per cent during the year. It did drop to 3.04 per cent in the first week of January when the liquidity sugar rush pulled down to short-term commercial paper yield for best-rated corporations below 3 per cent.
Too much money had made the so-called liquidity adjustment facility, or LAF, corridor ineffective, prompting the RBI to opt for a ~2 trillion, 14-day variable reverse repo auction for draining excess liquidity. The repo rate, at which banks borrow from the RBI (4 per cent now), and reverse repo rate, at which they park excess money with RBI (3.35 per cent), form the corridor — a band for the overnight money; the shortterm rates should be above this.
The excess liquidity in the system, which was ~8.4 trillion in May 2020, was ~5.5 trillion (excluding the government cash balance with RBI) last Friday.
The 14-day variable reverse repo auction has pushed up the yield on 91-day treasury bills and other shortterm money market instruments. One expects this window to remain open. It’s also time for the RBI to raise the cash reserve ratio (CRR), or the money that commercials banks keep with the RBI on which they don’t earn any interest. It was cut to 3 per cent (of banks’ net demand and time liabilities, a loose proxy for deposits) last March for one year.
Of course, RBI’S dollar buying will add to liquidity. Every dollar bought releases an equivalent amount of rupee into the system, but the RBI can postpone the infusion of rupee liquidity by entering into forward contacts (sell/buy swaps) in the forex market. It has been doing so.
Reinstating CRR at its old level will soak up ~1.5 trillion. Add to this, the reverse repo auction. Together, they will drain 3.5 trillion from the system. Of course, the RBI can cut the size of the reverse repo auction and make the unwinding process gradual.
This should not unnerve the market. It’s logical and the need of the hour when the Economic Survey is talking about a V-shaped recovery and 11 per cent GDP growth in 2022. The RBI announced the 14-day reverse repo auction when the overnight rates dipped below the reverse repo rate and the short-term yield curve was distorted. That had led to a lot of apprehension. In a likely no-action policy, RBI Governor Shaktikanta Das’s challenge will be assuring the market players that even though the central bank is on an unwinding mode, they have nothing to worry about.
After all, the rate setting body of the Indian central bank had in the not-so-distant past “unanimously” decided to continue with the accommodative stance of the monetary policy as long as necessary — at least through the current financial year and into the next year — to revive growth while ensuring that inflation remained within the target, going forward.
The good news is that inflation dropped to 4.59 per cent in December — within the RBI mandate (4 per cent with a 2 per cent band on either side) for the first time in the current financial year. In January, it could drop to 4 per cent or even below. Since April 2016, when Indian central bank opted for the inflation mandate, barring two exceptions — July 2017 (6.07 per cent) and June 2017 (1.46 per cent) — it was on the ball till November 2019.
In December 2019, inflation rose to 7.35 per cent and, for the next one year, barring March 2020, it remained above 6 per cent. That’s in the past. It could veer in the range of 4-5 per cent in 2021 and hence there is no need of raising the target when the inflation mandate is due for review in April.
Both the repo rate and the reverse repo rate have been at their historic lows. Despite drop in inflation, there is no need for a rate cut now. Beyond hype, if the Budget creates a platform for growth, the RBI will have to change the stance of the policy but that won’t happen now or even in April.