RBI keeps rates unchanged, but hints at normalization of liquidity surplus

-The banking system’s liquidity surplus is humongous. Though it helps in economic revival by making cheaper funds available, such large surplus is not required. For perspective, today’s surplus is double that of the post-demonetization level, when huge amount of money flowed to banks;

-Markets were anxious about whether the RBI would hike the reverse repo rate (currently at 3.35 percent) marginally. They were looking for cues on interest rate normalization and whether the huge system liquidity surplus would be reduced.

Status quo maintained

The RBI maintained the repo rate at 4 percent and the reverse repo rate at the current level. It also reiterated that it will “continue with the accommodative stance as long as necessary to revive and sustain growth on a durable basis.” That is, RBI prefers growth revival in the economy at this juncture, over real returns for savers. Apart from maintaining rates at current levels, what else did RBI do? The huge banking system liquidity surplus would go through the process of normalization, which was hinted at today. To understand the message on normalization of liquidity surplus, there is one technicality. There is a Government Securities Acquisition Program (G-SAP), under which the RBI commits a quantum of purchase of G-Secs, which supports the Government’s borrowing program and adds to the liquidity in the system. In the first quarter of this year, April-June 2021, the quantum was Rs 1 lakh crore (INR 1 trillion) and next quarter, July-September 2021, it was Rs 1.2 lakh crore (INR 1.2 trillion). For this quarter, Oct-December 2021, no G-SAP was committed. It was announced that G-SAP or other support measures such as Open Market Operations (OMO) will be conducted “as and when required.” The reluctance to commit indicates that the RBI is not comfortable with adding more liquidity to the system.

Now we come to another key takeaway from today’s review.

Going easy on inflation

Inflation is an issue nowadays, which is the other factor that is making real returns for savers negative, as mentioned earlier. In the policy review in June 2021, RBI had predicted CPI inflation for the year 2021-22, at 5.1 percent. In the previous policy review of August 2021, the projection was revised upwards to 5.7 percent for the year. Today, the projection was revised downwards to 5.3 percent. We already have the data for Q1, i.e., April-June 2021, which was 5.97 percent. In July and August 2021, it averaged 5.45 percent. The RBI projection made today is 5.1 percent for the July-September quarter of 2021. For Q3, i.e., October-December 2021, the projection now is 4.5 percent, against 5.3 percent expected in August 2021. So, there is substantial easing in inflation expectations, giving the RBI more time to normalize interest rates. For Q4, i.e., Jan-March 2022, inflation projection was maintained at 5.8 percent. Inflation expectation for Q1 of next year, i.e., April-June 2022, is now marginally higher at 5.2 percent from 5.1 percent in August 2021. Projection for GDP growth for 2021-22 has been maintained at 9.5 percent, the same as that in August 2021.

In future, even if the RBI reduces the banking system liquidity surplus, it will only come down from humongous to huge and, sometime in future, to adequate surplus. Hence, for banks to raise deposit rates, it will take time, because they are sloshed with surplus currently. The reduction of floating-rate home loan rates to 6.5 percent by certain banks has been made within the current interest rate structure to cash in on the festive season demand. Even here, there is a spread over the reverse repo rate of 3.35 percent, which is high as per historical standards. From RBI’s perspective, interest rates have plateaued and are not going to be reduced any more. Rate normalization is a matter of time. It would start by bringing liquidity surplus to adequate levels. Till then, the economy will be aided by the support from the RBI in the form of cheap and huge availability of money, and savers/depositors will have to bide their time.