Reverse repo to suck out excess liquidity

Focusses on inflation management; keeps repo rate unchanged

MUMBAI: The Reserve Bank of India’s (RBI’s) monetary policy committee (MPC) on Thursday decided to raise the reverse repo rate, at which it drains excess liquidity from the banking system, by 25 basis points, reflecting its steadfast pursuit of inflation management.

The unanimous decision by the six-member committee to raise the rate to 6% is largely to ensure that banking system liquidity is consistent with neutral monetary policy stance RBI adopted in February.

One basis point is one-hundredth of a percentage point.

RBI reiterated that it would use the tools at its disposal such as cash management bills and market stabilisation bonds to ensure that liquidity is brought close to a neutral (neither surplus nor deficit) level. It also said another tool, the so-called Standing Deposit Facility, under banks which can park their funds with RBI without receiving bonds as a collateral, was under examination by the government.

Average surplus liquidity in the banking system was ₹4.4 lakh crore in March and economists expressed concern that this would fuel inflation ahead.

“When it comes to inflation, the MPC is choosing to be conservative,” said Gaurav Kapur, chief economist, IndusInd Bank. “It has reiterated 4% inflation in the medium term as a core objective. Raising the reverse repo rate is a step towards ensuring that the liquidity management is in line with the neutral stance.”

While the committee noted that risks to inflation are “evenly balanced” currently, it also listed several threats. The main upside risks come from the uncertainty surrounding the monsoon, the implementation of the house rent allowance component of the seventh central pay commission award, and one-off effects from the goods and services tax.

Wholesale inflation soared to a 39-month high of 6.55% while retail inflation too inched up to 3.65% in February, signalling that inflation continues to be a concern for the regulator. Many economists expect no further rate cuts this financial year.

“The policy has highlighted the upside risks to inflation. This means the central bank is keeping a close watch on domestic risks. We are therefore looking at a prolonged pause before any action is taken this year,” said Upasna Bharadwaj, senior economist at Kotak Mahindra Bank.

In a separate report , RBI’s staff economists have projected 4.9% consumer price inflation in the quarter ending March 2018 and 4.6% in the three months ending March 2019, both higher than its medium-term target.

Two other facts highlight this risk. One, household inflation expectations continue to rise. The March round of the central bank’s survey of urban households showed an increase of 20-50 basis points in inflation expectations over the December round, when they had declined.

Two, RBI has projected gross value added (GVA) growth of 7.4% for the current fiscal year and 8.1% for fiscal 2018-19.

“The output gap (the gap between potential output and what the economy is actually producing) is closing. Consequently, aggregate demand pressures could build up, with implications for the inflation trajectory,” the policy statement said.

The central bank meanwhile kept the repo rate, at which it infuses liquidity into the banking system, unchanged, while reducing the Marginal Standing facility (MSF) rate (at which banks borrow from RBI beyond what is allowed under the repo window) by 25 basis points to 6.5%

“Banks have reduced lending rates, although further scope for a more complete transmission of policy impulses remains,” the statement said.