Is the RBI’s policy stance aligned with inflation and liquidity management ?

In the monetary policy announcement, the Reserve Bank of India (RBI) has chosen to keep key policy rates unchanged, citing multiple factors including elevated food inflation, weather-related disruptions, and geopolitical uncertainties. This decision reflects the RBI’s focus on managing inflation within acceptable limits while also addressing liquidity challenges stemming from the withdrawal of high-denomination currency notes.

The central bank has introduced an Incremental Cash Reserve Ratio (CRR) as a measure to manage surplus. This move comes as the RBI aims to strike a balance between sustaining liquidity in the banking system and preventing excessive money supply that could potentially contribute to inflationary pressures.

Madhavi Arora, Lead Economist, Emkay Global Financial Services, highlighted the RBI’s cautious stance on inflation, particularly its attention to durable elements of core inflation despite recent volatile food prices. She emphasised that while a transitory element exists in food inflation, the ongoing food shock led to a material revision of near-term and FY24 inflation forecasts by the RBI. Arora expects the reversal of food inflation to be more significant than the central bank’s expectations, potentially impacting near-term inflation averages.

Regarding the liquidity management strategy, Arora acknowledged the temporary nature of the current liquidity deluge, which she believes will start reversing from September onward. She commented on the choice of the incremental CRR as a liquidity tool, suggesting that it aligns with the RBI’s stance of withdrawing accommodation without significantly disturbing the banking system’s dynamics.

The impact of this policy decision on interest rates and borrowing costs was also discussed. While Ms. Arora anticipated a mild hardening of money market rates due to the new CRR measure, she projected a potential upside of around 10-15 basis points in short-term rates over the next one to two months. Additionally, the podcast covered the RBI’s acknowledgement of elongating loan tenures and its potential impact on different loan segments, particularly affecting personal loans more than home loans.

The RBI’s decision to maintain the status quo on key policy rates while introducing an incremental CRR reflects a cautious approach to manage inflation and liquidity challenges. The central bank’s focus on durable elements of inflation and its anticipation of a reversal in food inflation’s impact underscore its commitment to maintaining price stability and a balanced economic environment.

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