RBI Resists Urge To Fix What Ain't Broken, Holds On The Rates

Yesterday, the RBI Governor announced that the Monetary Policy Committee (MPC) decided to keep the policy rates unchanged – and continue with an accommodative stance.

What this means is that the Reserve Bank of India will continue to prioritise growth and the MPC recognizes the need to maintain an accommodative stance till we recover some of the lost output due to the pandemic.

It is ironical that in India, the central bank is more appreciated when the rates are hiked – irrespective of whether they should be hiked or not. Thus, even announcements of status quo on rates or rate cuts are viewed negatively by a section of journalists and commentators.

Luckily, public market participants do not take their commentaries seriously – and rightly so, as the decision to increase or decrease rates must be based on the policy objectives of the central bank.

Many may point that price stability is the stated objective by achieving an inflation target of 4 per cent (+/- 2%) which is true, but meeting that inflation target consistently would have meant a more accommodative approach to prevent capital erosion.

Thus, the decision to maintain an accommodative stance combined with a higher priority to growth is consistent to prevent loss of sizeable capacity in the economy which could have further consequences going forward.

Many have also criticised the institution for being too accommodative – or for proactive yield curve management. I am curious, when did any central bank get criticized for assisting fiscal policy during a crisis of such magnitude. Monetary-Fiscal coordination becomes far more important in such times and thus, such critics need to revisit the practice of central bankers across the world.

It is worth highlighting that the CPI is off from where it was and that the real interest rates continue to be negative. It is important for these rates to be negative for a while longer as the output gap continues to be wide. With inflation back in the acceptable range, the RBI can actually keep the rates low for a while to aid a complete economic recovery.

Two points; first, low rates benefits borrowers, including those who borrow to own houses or buy cars.

Most people also are looking at consumer finance for buying electronic appliances. Therefore, interest rates do have an impact on household consumption and can push up the demand for certain sections.

With low mortgage rates, we are seeing a significant pick up in appetite for real estate assets even in markets where stamp duty is yet to be cut. Thus, there is significant scope to further assist the sector by state governments should they cut stamp duties.

However, the key announcement for the day pertains to allowing direct retail participation in the Government Securities market by developing a platform that enables people to have an account with the central bank itself. The decision has interesting implications as it will certainly allow a future rollout of central bank digital currencies – which require such an account as a pre-requisite.

Central bankers across the world are preparing for a rollout of digital currencies – and RBI should actually be ahead of the curve given our success with payment systems.

But the major objective behind the move appears to be different than meeting a requirement for CBDCs. The objective is to allow for greater participation in GSecs markets thereby assisting government borrowings.

Thus, it appears to be a scenario where the central bank is facilitating a part of the savings directly from savers to the government. These savings would have otherwise been parked either with banks or held as cash or perhaps be invested elsewhere. The most likely alternative for these savings if not direct GSecs would be Fixed Deposits as both these instruments offer a fixed coupon over a duration.

The difference is that GSecs can be traded which makes this instrument slightly more liquid – and thus, those holding GSecs have to be careful as trading in GSecs requires a different level of expertise than simply parking money in GSecs just as one would in fixed deposits.

The other change will be in the way households allocate their savings between different class of instruments. That is, if the GSecs offer a higher coupon than FDs then people may prefer them over FDs as they would be regarded as completely safe due to the sovereign guarantee.

However, the likely scenario is that GSecs would offer a lower rate than FDs which may invite limited retail participation. But the idea that people can buy GSecs directly – and RBI can facilitate savers to finance the deficit of the government directly means that RBI is looking at greater participation as a tool to minimise transaction costs.

This should, at least in theory reduce the cost of borrowings but whether that happens or not is anyone’s guess. Retail participants must, however, recognize that GSecs come with a different kind of risks and speculating in government securities requires a different kind of skillset and risk appetite than equities.

Overall, the decisions of the central bank are consistent as we see it committed to ensuring a complete economic recovery. Its decision to assist the borrowing plan of the government should give further confidence to investors that monetary-fiscal coordination is spot-on and we should see a strong economic recovery post normalization of economic activity.