By Sudhakar Shanbhag
The RBI faces a challenge of elevated inflation, higher government borrowing and significant capital inflows. CPI inflation has been outdoors the 2-6% tolerance band for seven months. Alongside, public sector borrowing is most likely to rise to about 16% of GDP in FY21. The RBI has understandably stepped up on state and central government bond purchases to handle the elevated provide. Finally, and most importantly, foreign capital inflows stay sturdy, initially led by FDI inflows, and lately a lot more by FII inflows. The RBI has been intervening actively in the FX industry. Since early April, its foreign currency assets have risen by USD90bn.
FX purchases have been a stronger driver of surplus domestic liquidity than bond purchases. If the RBI does not intervene in the FX industry, the rupee could appreciate, hurting export competitiveness. If it does intervene, it would add to the currently elevated banking sector liquidity, stoking inflation worries additional. It’s tricky to predict when these significant foreign capital inflows will cease.
Fiscal and monetary policymaking about the globe has come to be far a lot more adventurous and unconventional. The final couple of months have witnessed a dramatic rise in the use of terms such as Modern Monetary Theory (MMT), ‘no more austerity’, QE-infinity, yield curve manage (YCC), and so on. And these have implications for EMs.
Even if EMs do not pursue a lot of of these unconventional policies, they could nonetheless locate themselves at the getting finish of loose policy in sophisticated economies. And that could turn out to be a double-edged sword. On the 1 hand, sophisticated economies would be undertaking a lot of the easing of monetary circumstances for EMs. But on the other hand, the significant quantum of easing could come to be a policy headache for some. For instance, loose policy abroad resulting in continued inflows into India, stoking domestic worries such as inflation.
The RBI will possibly have to juggle deftly by way of this period, striking a balance among its objective on inflation, bond yields and the rupee. To this finish, the RBI will be properly served by not generating alterations to the repo price (at present at 4%) or its accommodative stance in the upcoming policy meeting. However, it might have to update its macro forecasts on inflation and development. The RBI might also want to share its views on current developments such as the liquidity glut at the quick finish and its most likely technique on it.
(Sudhakar Shanbhag is Chief Investment Officer at Kotak Mahindra Life Insurance Company Limited. Views are the author’s personal.)