The Economic Times - - Rbi Monetary Policy -

The Re­serve Bank of In­dia, in its firstbi-month­ly­pol­i­cyre­view­for FY17, re­duced the bench­mark repo rate by 25 ba­sis points (bps) to 6.50%. Mone­tary eas­ing was widely ex­pected af­ter en­abling con­di­tions in the form of com­fort­able in­fla­tion tra­jec­tory, gov­ern­ment’s com­mit­ment to­wards fis­cal­pru­dence­an­dreforms,and global con­di­tions de­vel­oped favourably over the last few months. While mone­tary eas­ing is im­por­tant and was due by all counts, the com­plete over­haul of theliq­uid­i­tyframe­worke­merged as the piece de re­sis­tance.

The ex­ist­ing frame­work on liq­uid­ity was put in place in May 2011. Since then, the pol­icy stance was to keep liq­uid­ity in deficit mode with -1% of NDTL be­ing as­so­ci­ated with the usual level of com­fort. While this frame­work served well dur­ing the en­su­ing phase of mone­tary tight­en­ing, it cre­ated hin­drance for ef­fi­cient trans­mis­sion when the eas­ing cy­cle com­menced from Jan­uary 2015 on­wards.

The re­vised liq­uid­ity frame­work now makes a struc­tural shift by grad­u­ally mov­ing to­wards neu­tral from a hith­erto tight regime. Amidst ex­ist­ing deficit of ~2% of NDTL, this will in­volve a sub­stan­tial in­fu­sion of liq­uid­ity through RBI’s money mar­ket op­er­a­tions. As in­di­cated in the post-pol­icy press con­fer­ence,theRBI­ex­pects1-2years­for com­plete mi­gra­tion to the new liq­uid­ity regime. This con­ser­va­tive lib­eral ap­proach could, how­ever, be a damp­ener as the ex­ist- ing neg­a­tive out­put gap in the econ­omy calls for com­pre­hen­sive pol­icy sup­port on all fronts.

A faster mi­gra­tion to the new liq­uid­ity regime, along with the an­nounced re­duc­tion in pol­icy cor­ri­dor (MSF Rate - Re­verse Re­poRate)to100bps­from200bps and re­lax­ation in min­i­mum dai­lyCRR­main­te­nanceto90%from 95%, will im­prove mone­tary pol­icy trans­mis­sion along with the in­tro­duc­tion of MCLR for banks andthere­cen­tre­duc­tion­ins­mall sav­ings rate by the gov­ern­ment.

The move to­wards a neu­tral liq­uid­ity frame­work will re­quire the cen­tral bank to man­age its bal­ance sheet in a dy­namic man­ner. Mak­ing a clear distinc­tion be­tween­short-termliq­uid­ityand long-term durable liq­uid­ity, the RBI now in­tends to pri­ori­tise durable liq­uid­ity and then use its­fine tun­ing op­er­a­tions to make short-term liq­uid­ity con­di­tions con­sis­ten­twith­the­p­ol­i­cys­tance. What this im­plies is that in times of sub­dued net forex in­flows, the RBI is likely to read­ily in­fuse durableliq­uid­i­tythrough­bond­pur­chases via the OMO route.

So, why did liq­uid­ity be­come so im­por­tant?

One needs to recog­nise that in­cre­men­tal mone­tary ac­com­mo­da­tion is now get­ting in­creas­ingly con­tin­gent upon the mon­soon out­turn. While pre­lim­i­nary in­di­ca­tors are point­ing to­wards a favourable out­turn, the specifics in terms of spa­tial distri­bu­tion, etc, would also mat­ter equally. How­ever, with the event still 3-4 months away, this near-term un­cer­tainty on in­fla­tion­can­not­beal­lowed­to­pro­vide a bind­ing con­straint when eco­nomic growth still re­quires pol­icy sup­port from all fronts.

As such, the regime change in liq­uid­ity will help en­hance mone­tary pol­icy sig­nals and en­sure quicker trickle-down im­pact on growth. This will pro­vide the RBI a bang for its buck.

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