Moneycontrol Pro Panorama | Liquid cheer for markets, a forecasting lesson for RBI

While a blockbuster economic growth data had dimmed the expectations of a rate cut, ironically the delivery of one wasn’t the main attraction today. The highlight was the liquidity measures that resembled a central bank walking into a bar and saying, “all drinks on me”. In a more professional parlance, the central bank has front loaded measures.

The RBI announced Rs 1 trillion worth of government bond purchases to infuse durable long-term liquidity into markets and also a three-year buy-sell swap for $5 billion that will support the rupee without denting liquidity. Governor Malhotra explained in detail how market participants must assess liquidity and how short-term frictions in liquidity will be handled by the central bank through its daily liquidity measures. The bond purchases are for infusing long-term durable liquidity and should not be seen as a signal on bond yields. Also, at times, the RBI may drain liquidity through its repo auctions even as it infuses through bond purchases. All of this is fine.

The bond market has got what it has been demanding for long: the RBI as a buyer to take off some supply. Yields dipped today and analysts are now pencilling in a comfortable slide to 6 percent in the benchmark 10-year segment. That would mean the borrowing cost of the government comes down which invariably will be transmitted to other interest rates in the market.

This makes the job of bankers a tad difficult. After a long stretch of multiple quarters, bankers were hoping to juice out some margin improvement by avoiding a cut in lending rates. In fact, in October, the weighted average lending rate for fresh loans had risen because banks increased the credit spreads to keep loan rates from falling. With the rate cut and the liquidity infusion, lenders will have to pass on some of this to borrowers. That could put a bump into the margin improvement road. For now, this hasn’t taken the wind out of the sails of banking stocks.

Dinesh Unnikrishnan explains in detail what the measures mean to the economy in this piece here.

While it has been a much-needed liquidity cheer for markets, this policy is also an opportunity for the RBI to examine the health of its forecasts. The central bank revised its inflation forecast for the fifth time and brought down the projection of retail inflation to 2 percent for FY26. It changed its growth projection for the second time and now expects GDP growth to be 7.3 percent for FY26.

Forecasting economic variables is a mug’s game and even though central bankers have to undertake it, the exercise has become more and more challenging and often embarrassing. Indeed, even in the past, the RBI has underestimated or overestimated inflation consistently and has done the same on growth. Its more sophisticated counterpart the US Federal Reserve is no exception. The Fed had an embarrassing episode of missing the inflationary pressures of the economy and grossly underestimating not just the extent but even the nature of price pressures.

Should central bankers chuck their models and adopt newer ones? Should they just ask ChatGPT?

As every market forecaster and their uncle begin to predict 2026, central bankers must clean up their models or else, join a group of shamans offering weird predictions. This FT piece, free to read for Moneycontrol Pro subscribers, explains why central bankers are resembling shamans on inflation rather than seasoned technocrats.

In defence of the RBI though, the quality of economic data for the Indian economy would do well with a lot of beefing up. As RBI former governor YV Reddy said, “Everywhere around the world, the future is uncertain. In India, even the past is uncertain.”

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Aparna Iyer
Moneycontrol Pro