Just before the monetary policy was announced on the 6th of April, it
was assumed that there would be a rate hike for sure. The rationale pursued in
most arguments went this way. The uncertainty of the monsoon was a threat to
any inflation projection. The government borrowing programme as also the
redemption of TLTROs would put pressure on liquidity. The bond yields at the
lower maturity end spiked as liquidity tended to be tight. Global uncertainty
increased as the bank failures in the USA cast a shadow. The cut in output by
OPEC spooked up oil prices. The Fed had already indicated that the rate cycle
was not yet over and there would be more to come. Core inflation was sticky and
unlikely to come down. More importantly the market indicator, OIS (overnight index
swap) pointed to 6.75%. Then came the policy.
The RBI surprised the market with a ‘no change’ in both repo rate and
stance. This should not have altered the sentiment significantly. But the
difference was made with the language that went with the commentary which when
read along with the interaction with the media turned things around. Bond
yields have come down significantly even though none of the other factors
mentioned have changed. So what all has the RBI actually said?
First in the list is the reiteration of the fact that the RBI action so
far is not 250 bps but 290 bps. This is the first time that the reference has
been made to 40 bps hike which is the SDF (standing deposit facility) rate that
came higher than the reverse repo which is now fixed at 3.35%. This was a very
innovative signal passed on to the market. Like the bard had said a rose by any
other name would smell as sweet, so does the reverse repo having a new version
called SDF. It is the same window that allows banks to put in surplus funds
with the RBI at 25 bps more than the repo rate.
Second, there has always been talk on transmission that is linked to the
deposit or lending rates which are less flexible given the institutional
factors. But the commentary spoke of how the repo rate hike was transmitted to
the call money market where yields have gone up from 3.32% to 6.52% over the
year. The call money rate normally would always have the repo rate as a ceiling
as no one borrows normally at a rate higher than the policy rate when the window
is open. But this announcement had the impact of conveying satisfaction on the
transmission part.
Third, the statement explained what accommodation was. This has been an
enigma given that liquidity was normally associated with accommodation which
was getting tight at that point of time. An example was provided to explain
this. The repo rate of 6.5% was last associated with inflation of 2.0% in 2019
while today is going with inflation of 6.4% or its whereabouts. This means that
there is already a lot of accommodation that needs to be withdrawn. Therefore
the stance becomes clear now.
Fourth, the RBI has also clarified that monetary policy was driven
mainly by domestic factors when the question of the Fed action came up. This
was different from the September policy where the statement made a strong
reference to the Fed action as being one of the shocks that was pervading the
world which could not be ignored. This cleared the air to the market that the
Fed action on rates would matter. Hence even though the Fed would be raising
rates, this would not ricochet to our perimeter.
Fifth, the inflation forecast was lowered very marginally from 5.3% to
5.2%. This again sounded the bell that all was under control and things like
oil or monsoon, though risks to the inflation numbers, need not be considered
seriously today.
Last, in the course of the meeting with the media, the concept of real
interest rates also came up. With the RBI’s projection of 5.2% inflation in the
fourth quarter of FY24, the current repo rate would yield a real return of
1.3%. In February the forecast for the fourth quarter was 5.6% which gave a
real repo rate of 0.9%. Now it has gone up to past 1%.
Putting all these factors together the language conveys the feeling that
this rate hike cycle has ended. This is a powerful message sent which also
shows satisfaction at the impact of the hikes invoked so far. The response was
a sudden decline in bond yields in the market even though nothing has changed.
In fact even the stock market has taken heart at this messaging and responded
in an affirmative manner.
This really show that language is very powerful when it comes to
monetary policy. While announcing a ‘no-change’ in policy rates, the RBI has
maintained that the decision holds for the present meeting only. This keeps
open the doors to invoke hikes in future if warranted. From a central bank
standpoint, the messaging has been quite direct of being ‘watchful’. This is
what economists mean when they say that often ‘language’ is more powerful than
policy action. This is more so because often policy action is anticipated and
tends to be less potent as it becomes predictable. But speaking straight has
the
advantage of leaving it to the market to interpret even though the
official position is that everything holds only until the next policy in June.
But, markets are not rational and have their own way of interpreting the prose.
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