India seen breaking ranks with peers on unwinding easy monetary policy.

India’s central bank will likely go slow on normalizing its monetary policy settings.

Published: December 29, 2021 12:56Bloomberg

New Delhi: India’s central bank will likely go slow on normalizing its
monetary policy settings, breaking step with hawkish global peers to
ensure a durable recovery in Asia’s third-largest economy, according to
economists.

Policy makers will stick to their resolve of keeping their stance easy to achieve the growth goal for

now, said economists, including Standard Chartered Plc’s Anubhuti Sahay. They will instead focus on

the tricky task of sponging away liquidity, leaving just enough to keep the economy ticking without

adding to inflationary pressures.

Reserve Bank of India (RBI) Governor Shaktikanta Das, who last year called for coordinated policy

response to the pandemic, this month cited risks from Omicron for continuing support to the

economy despite calls from a colleague for abandoning the accommodative bias. India’s stance is at

variance with the hawkish turn at key global central banks from the U.S. Federal Reserve to the Bank

of England as they battle inflationary concerns.

Silent on rates

“Relative to other central banks, it might seem RBI has neither started hiking nor talking about the

possibility of rate increases,” said Sahay, head of South Asia research at Standard Chartered. “We

need to consider that such countries did not have strict lockdowns like India or have much higher

inflation relative to their historical trend.”

Michael Debabrata Patra, RBI deputy governor and monetary policy committee member, recently

cited a flattening Phillips curve - a theory that plots the relationship between jobs and wages - to

conclude that demand conditions were weak enough to keep policy easy for sometime.

That’s “providing some maneuvering room for monetary policy to support the recovery without

being hemmed in by demand-driven inflation concerns,” Patra said, referring to the curve which

tends to steepen when employment rises, pushing wages higher and stoking demand-led inflation.
Although the RBI kept its growth projection unchanged at 9.5 per cent for the current fiscal year

ending March, it is forecasting a slower expansion of 7.8 per cent next year. It sees inflation peaking

in the January-March period before stabilizing in the next two quarters at 5 per cent - within its 2 per

cent tot 6 per cent target band - allowing it room to support growth.

Besides, a huge buffer of nearly $650 billion in foreign exchange reserves, gives policy makers the

space to insulate an emerging economy like India from the volatility that comes with almost every

Fed tightening cycle.

Elephant in room

Nevertheless, the central bank has been keen to address the huge liquidity overhang in the banking

system, which HSBC Holdings Inc. recently described as the “elephant in the room.” Liquidity is likely

to remain elevated around the 6 trillion-rupee ($80 billion) mark over fiscal 2023 and 2024, according

to projections by the bank, down from around 10 trillion rupees earlier this month.

On its part to rebalance the liquidity in the system, the RBI is migrating the excess cash that banks

park with it from the fixed-rate reverse repo to the auction-based variable rates, over which it has

better control.

As part of that migration, the RBI will aim to mop up 7.5 trillion rupees via 14-day reverse repo on

Dec. 31. It shocked markets last week by introducing a shorter 3-day variable reverse repo, further

pushing up short-end rates.

“Higher money market rates and an expected hike in the reverse repo rate ahead should be seen as a

function of liquidity trending down from the current record surplus, rather than a move by the

central bank to tighten policy,” he wrote in a note.

Questions

Focus on the boldfaced vocabulary. Try to explain their meanings or provide a synonym

Hawkish =  contentious, opposed to  bélliqueux

hemmed in = contain, to limit

buffer = un amortissement

overhang = surplus

to mop up= to remove, to absorb

1. How have Indian policymakers managed to control inflation?

According to the article, Indian policymakers have managed to control inflation by keeping their

monetary policy stance easy while focusing on sponging away liquidity to keep the economy ticking

without adding to inflationary pressures. Additionally, the RBI has a target band for inflation of 2-6%,

and it is currently forecasting that inflation will peak in the January-March period before stabilizing in

the next two quarters at 5%, which is within its target band

2. What does the statement « to sponge away liquidity » suggest? Which consequence(s)

does it entail?

The statement "to sponge away liquidity" suggests that the RBI is trying to reduce the excess cash
that banks park with it, which has been described as the "elephant in the room" by HSBC. By
sponging away liquidity, the RBI aims to rebalance the liquidity in the system and prevent inflationary
pressures from building up. The consequence of this action is that it could lead to higher money
market rates and an expected hike in the reverse repo rate.

3. Which bias does the RBI Governor focuses on?

The RBI Governor is focusing on continuing to provide support to the economy despite risks from
Omicron. The article states that he has cited risks from Omicron for continuing support to the
economy despite calls from a colleague for abandoning the accommodative bias.

Accommodative bias: to exploit a misconception that some bankers have by injected liquidity in
economy in order to cop with pressures.

4. How is the Phillips curve used to substantiate the point expressed in this article?

The Phillips curve is used to substantiate the point expressed in the article that demand conditions in
India are weak enough to keep policy easy for some time. The flattening Phillips curve indicates that
employment is not rising enough to push wages higher and stoke demand-led inflation, which
provides some maneuvering room for monetary policy to support the recovery without being
hemmed in by demand-driven inflation concerns.

Phillips curve used to measure the level of unemployment rate and the level of wages.

To make sure that the monetary policy used doesn’t change.

 5. How would you define an emerging country? -> which criteria would you use?

An emerging country can be defined in various ways, but generally, it refers to a developing country
that is transitioning from a low-income economy to a middle-income economy. Some criteria that
can be used to categorize a country as an emerging country include GDP per capita, economic growth
rate, industrialization, urbanization, and human development indicators

As far as you are considered, would you categorize India as an emerging country?

6. Why should this move be seen as a technical tool (liquidity) rather than a move by the
central bank (decisional) ?

This move should be seen as a technical tool rather than a move by the central bank because it aims
to rebalance the liquidity in the system rather than tightening monetary policy. The RBI is migrating
the excess cash that banks park with it from the fixed-rate reverse repo to the auction-based variable
rates, over which it has better control. While this move may lead to higher money market rates and
an expected hike in the reverse repo rate, it is primarily aimed at reducing excess liquidity rather
than tightening monetary policy.