RBI deploys some less-noticed smart moves to head off geopolitical risks

The economic skies are clearly overcast, clouded by the tensions in Europe.

India faces the prospects of lower growth and higher inflation than previously estimated, according to the Reserve Bank of India’s (RBI) ‘Review for April 2022’.

It is in this backdrop that many analysts feel RBI needs to raise interest rates substantially to control inflation, but appears to be lagging “behind the curve”.

Instead, RBI decided to hold steady its main policy rates – the repo and reverse repo on April 8.

Central banks’ key mandate is to fight inflation, while governments always want easy policy rates to fuel growth. There’s a perception RBI was still chasing growth by pumping more money into the economy, instead of inflation by hiking interest rates.

However, a finer look into RBI’s liquidity framework announced last week and the April Review shows the central bank hasn’t undermined emerging risks. It has in fact undertaken some smart moves, factoring in the risks of the Ukraine war, broken global supply chains and rising prices.

Let’s look at the numbers that matter once again:

GDP: RBI projected a real (inflation-adjusted) gross domestic product (GDP) growth of 7.2% for FY 2022/23, lower than the previous forecast of 7.8%. GDP is a measure of output, and the widest measure of national income.

Prices: The central bank expects inflation to rise sharply to 5.7%, from 4.5% forecast in February.

Policy rates: Despite risks of lower growth and higher inflation, the six-member Monetary Policy Committee (MPC) voted to keep the repo (lending rate) and reverse repo (borrowing rate) steady at 4% and 3.5% respectively.

These rates are key to boosting credit, borrowing and investments by businesses in the economy as India pushes its nascent economic recovery. The MPC’s review of the economy is key to markets and general business sentiment. Lower rates, which increase money supply, make for easier borrowing both for government and businesses, thereby boosting growth.

Yet, despite not hiking these rates (to control inflation), RBI has effectively changed its liquidity framework, or the general policy regarding money supply. This is the crux of RBI’s changed policy stance, which is now leaning towards ‘hawkish’.

RBI has launched a standard deposit facility (SDF) for the first time at 3.75%. Note that this 25 basis points below the headline repo rate will allow the central bank to take money out from banks, thereby absorbing cash and shrinking money supply. This is obviously aimed at tackling inflation.

This one move has also rendered the reverse repo rate (borrowing rate) almost redundant despite being unchanged.

The marginal standing facility (MSF) rate — the rate at which RBI lends funds overnight to scheduled banks – has been set at 4.25% in case RBI feels there is a need to increase money supply, which is unlikely given high inflation.

Former World Bank chief economist, Kaushik Basu, in a tweet on Sunday, said the new policy stance of RBI was a “smart move”. He said RBI’s decisions now needed “complementary policies from the government. “Without those, I feel inflation will get worse.”