Moneycontrol Pro Panorama | Reserve Bank of India faces tough choice in monetary policy

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The massive central government borrowing programme will weigh on the Monetary Policy Committee when it meets tomorrow. The rate decision is expected on Thursday.

The Union Budget announced last week had pegged central government borrowing for 2022-23 at Rs 14.95 lakh crore. Add to that borrowing by the states and public sector enterprises, the overall public sector borrowing requirement will be Rs 19.9 lakh crore, according to State Bank of India.

The bond market is jittery and rates on long-dated government paper have spiked since the December policy. (Do check out our interview with S Naren on rising bond yields.)

Apart from that, large global central banks have turned increasingly hawkish (this will squeeze inflows towards emerging market bonds) and oil prices have risen bringing with them the spectre of inflation.

The consumer price inflation number for December at 5.6 percent could well be a portent of things to come.

This inflation focus and the economic recovery which is afoot necessitate that the RBI begins the process of policy normalisation. However, it is not as easy as it sounds.

Such a step will be in conflict with any support the Reserve Bank of India might have to extend towards government borrowings. Increasing credit growth also means that commercial banks might divert resources to lending rather than investing in government bonds. However, RBI picking up the slack through an open market purchase of bonds, for instance, will add to liquidity.

Second, remember that the advance GDP estimates pointed to a K-shaped recovery. There are sections of the economy lagging and a rise in interest rates could well end up hurting them.

Where does all this lead us? In all probability, RBI will try to thread the needle by offering soothing commentary on long-term rates while tightening by stealth like continuing to absorb more liquidity through variable reverse repo rate auctions.

It could also announce a hike in the reverse repo rate (this is outside the remit of the MPC) for the simple purpose of aligning it with rising short-term rates in the market and reducing volatility. But too sharp an increase could also send signals to the market that a repo rate hike is nigh, which it would want to avoid.

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Ravi Krishnan

Moneycontrol Pro