‘RBI can pare excessive liquidity even if stance is accommodative’

ASHIMA GOYAL, one of the members of the Reserve Bank of India’s (RBI’S) Monetary Policy Committee (MPC) voted in favour of keeping the repo rate unchanged and maintaining an accommodative stance during the August monetary policy review. In an exclusive interview with Manojit Saha, Goyal, who is a professor at the Indira Gandhi Institute of Development Research (IGIDR), says reducing excess liquidity is a discretion of the RBI and MPC members can only offer advice. Edited excerpts:

You have used the phrase “whenever normalisation starts,” indicating normalisation has not started yet though a section of the market believes that it started with the variable rate reverse repo (VRRR) announcement. What, according to you, will mark the start of the normalisation process? Is reverse repo rate hike the right indicator? The current VRRR is a short-term kind. It could just be a part of their normal liquidity management, especially since excess liquidity is very large. That is what they are saying. The market is just inferring from these actions. I don’t think there is enough evidence to say that normalisation has started. But the

point I want to make is that RBI can reduce excess durable liquidity, and respond as required based on outcomes, even if the stance is accommodative. Although the MPC sets the stance also, this basically determines potential repo rate actions —whether it can rise or stay the same or it can fall. The stance does not determine what happens to liquidity. That is RBI’S discretion. How they handle the excess liquidity or what happens to the reverse repo is their discretion. MPC members can only offer their opinion or advice.

You have said, “other normalisation can start when the stance is accommodative…”

This is what I am clarifying. That they can make changes in the amount of liquidity available, even change the reverse repo, when the stance is accommodative. Exceptional actions were undertaken during the pandemic. The gap between the repo and reverse repo is 65 bps, which is larger than normal. Durable liquidity is excessive. So, normalisation that reverses exceptional measures can happen in an accommodative stance. But that is the RBI’S call and not the MPC’S.

Do you think rate normalisation can happen only after the gap between repo and reverse repo is restored to 25 bps?

No. The process of closing gaps is itself normalisation. The whole band can move up while retaining a larger gap. But the repo rate cannot be raised unless the MPC moves into a neutral stance. But VRRR and other instruments aim towards smoother liquidity management so that rates stay in a small gap.

Can reverse repo be hiked while maintaining an accommodative stance?

Yes, as long as it is towards normalisation. Some of the exceptional measures can be reversed even if the stance is accommodative. The normal relationship between the repo and reverse repo can be restored even in an accommodative stance.

Under what circumstances do you think that accommodative stance can be changed to neutral?

That is when the MPC sees that the output gap is closed and demand pressures are affecting inflation.

Does that mean you are not worried about this persistent high inflation because you see it as transient?

I think we don’t know yet if it is persistent. That is the broader point I made in the MPC minutes. You see some rise in inflation because of supply shocks. Bottlenecks due to the pandemic raised inflation — but this is transient, even oil price inflation. We need to find out if there are second round effects that would make it persistent. But you don’t yet see signs of that. It is becoming clear that the rise in international inflation is temporary. Indian inflation has also softened.

Do you see the repo rate rising by the end of the current fiscal year?

I don’t want to make such a prediction. We are watching different aspects of the data, forward looking indicators as well as the realised outcomes. If we see growth is booming and inflation rising, then you need rate action. If there is a third wave, growth falls and unemployment is large, then you continue to stay accommodative. So, it depends on outcomes.

One of the MPC members said that RBI appears to be targeting 5 per cent inflation. Do you think

there is a risk that a significant part of the market participants also starts believing in that which could result in inflation expectation moving higher?

I don’t think so. Because RBI is not targeting 5 per cent inflation at all, they are targeting 4 per cent with a band of plus or minus 2 per cent. All they have said is that their current projection of inflation by next year is 5 per cent. That projection has a large band of uncertainty. This is their forecast, and not their target. You cannot confuse a forecast with a target. The target remains 4 per cent. In the current situation, when you are just recovering from a pandemic, we don’t know whether there will be a third wave. It would be very hawkish to say inflation is above the projection of your target, then raise your rate. But it is not wise to be such an inflation nutter. As long as inflation projections are within the tolerance band, you don’t have to tighten rates as yet.

In the current situation, when you are just recovering from a pandemic, we don’t know whether there will be a third wave. It would be very hawkish to say inflation is above the projection of your target, then raise your rate. But it is not wise to be such an inflation nutter. As long as inflation projections are within the tolerance band, you don’t have to tighten rates as yet”