As widely expected, the RBI’s MPC kept the policy repo rate at 4 percent at its second bi-monthly meeting this fiscal year. The current accommodative stance of monetary policy will also continue. The MPC is unanimous in the view that sustaining the growth impulses of the economy on a sustained basis continues to be the priority of the RBI, as the country reels in further devastation caused by the “second wave” of the pandemic. Covid-19. The initial reaction from the equity market was slightly positive and G-sec yields were slightly higher.

Despite the severe shock that the country’s employment and demand situation, especially in urban areas, suffered as a result of the “second wave”, the MPC lowered its GDP growth projection for 2021-2022 by just 100 basis points, compared to 10.5 percent. (announced earlier at its last bimonthly meeting) to 9.5 percent, but without indicating any risks, if any, for this projection.

The revised GDP growth rate is based on the forecast of a normal southwest monsoon, the resilience of agriculture and the agricultural economy in general, early indications of the adoption of Covid-compatible business models by businesses, signs of a global recovery and, most importantly, an early slowdown of the “second wave” in both urban and rural areas.

Implicit in this reasoning is the hope that the current vaccination campaign will be accelerated and that gaps in health infrastructure and vital medical supplies will be filled as soon as possible. While it is correct to say that central and state governments are now doing their best in this regard, it would not be realistic to expect dramatic results from their efforts.

The global recovery is indeed accelerating. But it will be premature to base too much optimism on its positive influence on Indian growth this fiscal year. According to the recently released PMI Services Index data for May 2021, foreign demand for Indian services declined in April 2021 at the fastest pace since November of last year. The overall index also posted a contraction. Business expectations are down again. Firms are experiencing rising input costs, but can only pass some of this on to customers due to weak demand. All in all, the risks of a decent recovery in growth in 2021-2022 are still numerous.

CPI inflation has performed well in recent months and this could continue for the remainder of the first half of 2021, thanks to favorable base effects. If the progress of the southwest monsoon is normal and the government succeeds in insulating the prices of essential foodstuffs from any supply disruption, CPI inflation in 2021-2022 is projected at 5.1 %, with globally balanced risks. . The downside risks are mainly related to the current surge in crude oil prices. It is a fair assessment.

Oversized Exchange Book

The RBI’s very aggressive dollar / rupee swaps involving spot sales and forward purchases of US dollars in recent months have caught the attention of many for a variety of reasons. The scale and pace of these operations was gigantic and unprecedented. Obviously, some controversy and confusion as to their true purpose and purpose has also surfaced.

To give a perspective, during the seven-month period from August 2020 to the end of February 2021, the RBI’s net forward purchase commitment through sell-buy swaps rose from nearly zero to $ 73 billion. dollars. One of the consequences of this build-up of sell-buy swap positions has been a rapid increase in forward premiums, making them significantly out of alignment with the interest differential between India and the United States.

For example, the six-month term premium peaked at 5.72% in March 2021. The surge in the dollar futures price, as a result, upset the equilibrium of the foreign exchange and money markets in more ways. than one, creating price distortions and modifying the incentives of market players: it suddenly made the hedging of import transactions more expensive, increasing the so-called “advances and delays” in the entry dynamic- exit or demand-supply of the forex market.

For the same reason, it made foreign currency inflows in the form of carry trades more attractive. Additionally, for counterpart banks that borrowed US dollar liquidity from the RBI for periods of up to 12 months, this was a huge opportunity, provided they could profitably use the resulting funds. While it is difficult to obtain granular information regarding the bank distribution of the dollar liquidity thus created by the RBI, it is evident that it is biased in favor of a few who have a strong international presence.

There is nothing wrong in itself, but this flies in the face of the RBI’s claim that it also aims to ensure that liquidity creation is equitably distributed among all stakeholders. Interestingly, the RBI has been seen doing buy-sell swaps in recent weeks, as a result of which forward premiums have fallen from their highs seen earlier, the premium. of six months being around 4.10% on Friday. It’s still much higher vis-a-vis the interest differential. In principle, this situation runs counter to the accommodative stance of monetary policy.

In one of three documents released on Friday, the RBI attempted to defend itself against criticism of its increased trading in the forex market in recent months. However, his carefully crafted account in this regard is long on generalities and the use of key words like “to pursue national goals, stability and order in market conditions, etc.” but short of providing useful information.

While the limits and constraints of the RBI to be fully transparent both with respect to its precise objectives and the way it assesses the impact of its market operations are fully understandable, it is nonetheless reasonable to assume that at some point the authorities will feel the need to communicate on the subject to all stakeholders in a more direct and meaningful way. Because there are serious and important issues here.

Going forward, a further cut in the key rate seems possible, as the RBI has cited the emergence of “some political leeway” in this regard due to better than expected headline inflation of 4.3%. in April. However, rising prices for raw materials and logistics are causing concern.

In all likelihood, the price of crude oil will hold the key. It hit a two-year high on Wednesday, with the Brent index surpassing $ 71 a barrel. The retail price of gasoline has already crossed the psychologically significant level of 100 per liter in several cities. The MPC urged the Center as well as states to “adjust” (read less and rationalize) excise duties, taxes and levies imposed on gasoline and diesel to contain input cost pressures emanating from their price. However, the prospects for that to happen soon do not look very bright.

The author is a former central banker and consultant to the IMF. Through the billion press



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