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It is now time for the MPC to start thinking out of the box
When monetary policy was presented on 06th August, the thrust was to keep the repo rates at 4% and hold on to the accommodative stance. However, with rising inflation, that stance is becoming more and more hard to explain. That is where, the need for an out of the box approach is really called for.
Written By Bani Thakkar
Table of Content
Learning from dissenting notes
In India, MPC meets have largely been about consensus on most issues. In most of the previous MPC meetings, the members have unanimously agreed on the repo rate and the monetary stance. In the latest policy minutes, it is evident that Jayanth Varma had reservations on giving an open-ended accommodative stance trajectory. While Varma agreed to holding repo rates, he dissented on the continuation of monetary stance as accommodative for an indefinite period. Varma has been a votary for a data driven approach for a long time. In this MPC meet, he has specifically put down his dissent to the stance. His argument is that the economic impact of COVID 2.0 has been fairly limited. Hence, there was no need to continue to assure that an accommodative stance would be held even when inflation had shot up above 6%. He reminded the MPC that the RBI inflation target was 4% and not 6%. While growth was essential, it could not be at the cost of inflation. What is more interesting is the solution to this issue that Jayanth Varma has proffered.
Out of the box approach
One of the objections that Varma had was to the discrete approach of the MPC. He felt that the job of the MPC was not to select between 0 and 1. Its job was to also look at proxy solutions which may mirror the same result even though the action point may not look like a rate hike or like a tapering of the accommodative stance of monetary policy. While Varma concurred on the need to hold repo rates at 4%, he called for a more flexible approach to the reverse repo rate. That is the rate at which the RBI borrows from the banks. The spread used to be 25 bps below the repo rate which increased to 65 bps as part of monetary easing. Varma is of the view that instead of raising repo rates, the RBI can raise reverse repo rates as it would not only correct the anomaly but have the same impact as repo rise.
How reverse repo hike helps?
According to Varma, with Rs.11 trillion of system liquidity, there was no need to give accommodative blank cheques. The out of the box approach would be to curtail system liquidity by raising the reverse repo rates and take it closer to the original 25 bps spread below repo rate. If the liquidity gets curtailed and the inflation tapers, then the need to hike repo rates may not be felt. It is time the RBI starts looking at such out of the box approaches. After all, COVID effect looks to last for much longer!