India’s RBI signals policy shift with focus on liquidity, prices

Bloomberg

India’s central bank signalled a shift in policy focus as it ramped up efforts to mop up excess liquidity in the banking system and raised its inflation forecasts, sending bond yields higher.
While the Reserve Bank of India’s (RBI) rate-setting panel decided to hold rates and keep its accommodative stance, it also voted unanimously to focus on “withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth.”
Governor Shaktikanta Das announced a new tool that will enable the monetary authority to soak up excess cash in the banking system by narrowing the
so-called interest rate corridor.
The statement dropped a pledge to keep policy loose “as long as necessary” for the first time since late 2019. Combined with increased efforts to tighten liquidity, economists said it marked a hawkish shift in the policy outlook.
India’s 10-year bond yield rose to 7%, the highest since 2019, as the RBI also raised its inflation and lowered its growth forecast.
A recovery in Asia’s third-largest economy is facing fresh challenges from the war in Ukraine and Covid-19 lockdowns in China, which risk exacerbating a global supply squeeze and price pressures. Das said the global economy is seeing “tectonic shifts” from the war and extreme volatility in commodity and financial markets.
“Caught in the cross current of multiple headwinds, our approach needs to be cautious but proactive in mitigating the adverse impact on India’s growth, inflation and financial conditions,” Das said.
The decision comes as many central bank peers pivot toward tightening, led by the Federal Reserve, which is expected to continue raising rates when it meets in May. Policymakers globally have started shifting their focus toward fighting inflation as recoveries from the pandemic begin to take hold.
A key announcement in the policy statement was the introduction of a new tool to soak up excess liquidity. The so-called Standing Deposit Facility will absorb cash from banks at 3.75%, with the central bank not having to provide any collateral in exchange.
The new mechanism, which was first proposed in 2014, will now form the floor of the interest rate corridor, basically pushing up the overnight rates without any direct tightening of policy. Earlier the floor was the reverse repo rate, at 3.35%.
Shorter bond yields led the jump in response to the announcement, with the four-year bond yield up 12 basis points to 6.15%, while the 10-year yield rose nine basis points at 7%, a level last seen in 2019.
The central bank raised its inflation forecast to 5.7% for the fiscal year that started April 1, up from its 4.5% in February. The central bank also sees gross domestic product growth during the year at 7.2%, compared with a previous outlook of 7.8%.
The RBI’s inflation forecast was a key focus heading into the decision, after drawing criticism from some economists after its last meeting in February for being too relaxed on consumer prices.
Russia’s invasion of Ukraine since then has piled on more potential pressures, including a surge in oil prices, leading Das last month to acknowledge the forecast needed to be reworked. He said during the policy statement that the RBI’s new growth outlook assumes crude at $100 a barrel.