A large enough liquidity deficit has become a persistent feature in the Indian banking system in recent weeks, pushing interbank rates often above the monetary policy corridor, requiring the RBI to inject liquidity. Does this mean the RBI’s stance has de dacto changed? It may be tempting to think so but there is many a slip between the cup and the lip. Few musings:
– Liquidity action is driven by stance, not vice versa. To be fair, the RBI has only preferred a modest liquidity deficit not a large one, to maintain sufficient not excessive tightness in rates, “while meeting the productive needs of the economy”. This is essential. They have never meant a credit squeeze, but sufficient tightness in rates.
– A part of current liquidity deficit owes to unexpected slowdown in government spending. The government is not likely to scale down spending for the full year but may actually be preserving ammo ahead of elections. When that spending flows through, some of the current deficit will ease.
– Inflation remains the paramount concern. Unless RBI projections show inflation aligning with 4%, it is hard to expect a softening of stance as well. In Feb meeting, the RBI will project unto q1 2025. That inflation forecast may be close to 4%, without much base aberration to look through. The question is will that be enough to flip, or one more quarter’s projection will be needed to be convinced? The latter does make for a compelling case, for RBI commentary to pass the test of consistency.