4 Members Favoured Neutral Liquidity Stand
Stance changed to assess how effect of demonetisation on inflation, output played out
Mumbai: The three representatives from the Reserve Bank of India (RBI) in the Monetary Policy Committee (MPC), and an external member had favoured a change in the liquidity stance from accommodative to neutral in the recent policy statement brought out on February 8. This move had taken the financial markets by surprise.
While all RBI representatives explicitly favoured a neutral liquidity stance, only one of the external members, Ravindra Dholakia, justified the neutral liquidity stance. He felt that the current (policy rate) is optimal for liquidity in the economy. Therefore, a change of stance from accommodative to neutral at this stage was desirable.
“It can impart the necessary flexibility for the monetary policy in future to respond to any development on either side,” Dholakia said. The two external members –– Chetan Ghate and Pami Dua –– did not make any reference to liquidity in their statements.
However, the decision of the MPC, which comprises three RBI repre- sentatives and three external members, to keep interest rates unchanged was unilateral, according totheMPCminutesreleasedbyRBI on Wednesday.
The RBI had kept its key policy rate –– the repo rate –– unchanged at 6.25% in its February 8 policy statements. The committee decided to change the stance from accommodative to neutral while keeping the policy rate on hold to assess how the effects of demonetisation on inflation and output played out.
RBI has conducted market liquidity operations according to a framework it had put in place in April 2016. It has been progressively moving the system level conditions to close to neutrality –– a level of liquidity adequate enough to meet demand. This stance is expected to continue. RBI expects surplus liquidity to decline with progressive remonetisation and the current abundant liquidity with banks is likely to persist till early 2017-18.
All the six members expressed concernsoninflation.Fourof them –– two external members (Pami Dua and Chetan Ghate) and two RBI representatives (Viral Acharya and Urjit Patel) expressed concerns that inflation was ‘sticky’ in certain segments.
The MPC is committed to bringing headline inflation closer to 4% on a durable basis and in a calibrated manner.
Ravindra Dholakia expressed concerns that state government budgets have been a cause of concern because the movement in their fiscal deficits largely determines the variation in the combined fiscal deficit of the country.