RBI to mop up surplus liquidity as it ‘rebalances
The monetary policy panel of Reserve Bank of India (RBI) decided to increase the amount of money absorbed through variable-rate reverse repo (VRRR) auctions.
Variable-rate reverse repo (VRRR)is a tool used by RBI to absorb excess liquidity from the banking system. Since Jan 2021, the Reserve Bank of India (RBI) has been taking out about ₹2 lakh crore from the banking system every two weeks. It has now decided to increase that figure substantially by around 14 Lakh Crore by the next two fortnights till the end of December 2021.
While the governor warned that the market should not read the above increase as the pullback in the RBI’s accommodative stance, many in the market had already seen this as the first step towards tightening the liquidity by the regulator. Sucking out the money in the system affects the demand for assets, including financial assets like shares and bonds.
As per many analysts, this is the beginning of RBI’s imminent exit from unconventional monetary easing.
Why is the RBI reducing liquidity?
The Indian economy was stuck between a rock and a hard place for close to 18 months now. The pandemic, and the lockdowns that followed, have hammered national income and the supply constraints have led to a price rise.
Inflation, in theory, is a result of too much cash chasing too few goods and services. For instance, since the outbreak of the COVID-19 pandemic, people still had to buy daily essentials like milk, vegetables, and eggs. However, because of the lockdowns, the vendors could not get the supply on time. So that pushed the prices up because people were willing to pay the extra amount for a timely supply.
As the lockdowns in different parts of the country lift, and the economy slowly opens up, the supply constraints may ease and there may be no need for the excess cash in the system.
RBI’s inflation forecast for the rest of the financial year has been raised to 5.7% from its earlier estimate of 5.1%. “At this juncture, RBI’s overarching priority is that growth impulses are nurtured to ensure a durable recovery along a sustainable growth path with stability.
As per the RBI governor’s statement, the endeavor of the Reserve Bank is to put in place an effective liquidity management framework that is consistent with an economy emerging out of the pandemic and having a nascent but strengthening recovery.
RBI Accommodative Stance / Monetary Easing
Literally the word accommodative means willing to fit in someone’s wishes or needs.
This happens when a central bank (RBI) attempts to expand the overall money supply to boost the economy when the economic growth is slowing down. The major aim is to increase spending.
Accommodative monetary policy is implemented to allow the money supply to rise in line with national income and the demand for money. This is also known as “easy monetary policy” or Loose Credit.
When the economy slows down, the central bank (RBI) can implement an Accommodative Monetary Policy to stimulate the economy. It does this by running a succession of decreases in the Interest rates, making the cost of borrowing cheaper.
This makes borrowing easier for businesses, which stimulates investment and expansion of operations. The immediate result of monetary easing is generally a boost in stock prices. In the medium term, it promotes economic growth.
However, if this policy remains for too long, it can lead to a situation in which there is a glut of currency or too many money chasing too few goods and services, leading to inflation. For this reason, most central banks alternate between policies of monetary easing and monetary tightening to encourage growth while keeping inflation under control.
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