The Monetary Policy Committee of the RBI, in its first policy review after the Budget, kept the policy rates unchanged, a move that belied the expectations of the market and economists. The Repo rate at 4 per cent and the Reverse Repo Rate at 3.35 per cent have been left unchanged.

The Repo Rate is the interest rate that banks pay to the RBI for borrowing money from it and the Reverse Repo Rate is the interest that the RBI pays banks for parking their money with it.

Some market analysts and economists had expected the RBI to bite the bullet and raise rates given the rising global inflation. Central banks world over led the US Fed Reserve and are calling time over their easy money policy. Inflation is rising in Europe and in the US, it is at a four-decade high.

The West’s easy money policy over the last two years, to counter the economic impact of the Covid pandemic, had flooded the developing nations with liquidity. The rise of stock indices, especially in India, over the last two years, was a direct result of this policy.

But it is hardly surprising that the MPC decided on a “status quo” on policy rates. This policy action is in sync with the recently announced Budget. The focus of this year’s Budget was on a huge hike in capital expenditure – with massive infrastructure spend, especially on transport, and logistics infrastructure under the rubric of the PM Gati Shakti.

And much of this spending will be done by the government, although it hopes to fuel a virtuous cycle of investment by “crowding-in” private investments. This government plan of course entails a massive borrowing, something which Finance Minister Nirmala Sitharaman had indicated in her Budget speech.

The MPC’s decision to hold policy rates has to be seen in this context. By refraining from a hike, the RBI is making it easier for the government to borrow from the market as it will keeping borrowing costs down.

Inflation worries

The RBI seems to have a rather benign view on inflation and for now does not see it as a problem. This is despite global oil prices holding firm. Retail inflation (Consumer Price Index) in January rose to a seven-month high to touch 6.01 per cent. This is above the RBI’s comfort level of 6 per cent at the upper level. The RBI’s inflation target is 4 per cent with a plus/minus 2 percentage point band. Food inflation was the main factor driving prices, which at 5.43 per cent is at a 14-month high.

But the RBI Governor Shaktikanta Das seemed surprisingly sanguine on the inflation front. After a post-Budget meeting with Finance Minister Nirmala Sitharaman, he said there was no need to panic and a 6 per cent inflation was on expected lines.

The RBI in its policy review has projected FY23 inflation at 4.5 per cent, which economists say is rather optimistic, especially given the global headwinds. Not surprisingly, India Inc and market players welcomed the RBI’s continued accomodative stance.

Taking a punt on capex

The RBI’s move (and the government’s) to keep lending rates low to aid the capex plan seems logical, but the vital piece in this jigsaw puzzle is private investment. The massive capex plan is expected to “crowd-in” private investments, create jobs, increase consumer spending and aggregate demand and lead to economic revival. This is the government plan and the RBI’s accomodative policy (by keeping lending costs low) is supposed to aid this.

But whether this scenario plays out on the ground is a million-dollar question. For the time being, both the government and the RBI are pinning their hopes on this strategy.

Apart from inflation worries, D Subbarao, former RBI Governor, has warned of financial instability due to continued easy money policy. In a recent lecture at the Great Lakes-Union Bank Finance conference, he said, the enormous liquidity going around, coupled with low-interest rates will lure people to put money in riskier assets which will pose a threat to financial stability.

Subbarao, in the lecture, said, the challenge for central banks in the aftermath of the pandemic is to maintain a balance between growth and employment, inflation and financial stability.

Central bank governors need loads of luck for walking this tightrope at the best of times. At a period when world is trying to emerge from a once-in-a-lifetime pandemic, they could do with some divine intervention too.

Governor-govt, on same page

Union governments in the past have had their run-ins with RBI governors. The Modi government too had its share of controversies on this front. Raghuram Rajan’s exit raise eyebrows, and his successor Urjit Patel’s left abruptly after a particularly bruising scrap with the Finance Ministry.

By appointing Shaktikanta Das, a career bureaucrat who served in top posts in the Union Finance Ministry, the Modi government has ensured that the RBI Governor will play ball with the government.

Does this erode the autonomy of the central bank governor? That’s a debate for another day. For now, the Finance Ministry is only too happy to have its man on Mint Street.