Liquidity - a boon or bust? RBI’s attempt to recover and stabilize the economy

With the economic recovery coming into play, there is a sense of mixed feelings looming over.

Increased activities showed the recovery tracker rising from 103 to 105, and the PMI long-term average rising up to 53.7 from 53.5. This change came from both increased exports and imports activities. Until September, exports proclaimed higher figures, however, since September imports picked up too which also signified the demand from the domestic market. Another signifier was the higher than budgeted Tax revenues, especially the Corporate Tax Collections. With a positive trend reversal and increased vaccination rates, the up-coming few months also seems to have a strong positive outlook.

The picture isn’t as rosy as it may seem. The recovery tracker has only moved 5% above the February 2020 levels, core industries remained 2% below pre-pandemic levels, exports were 17% above the pre-pandemic levels and domestic consumptions remained 7% below the pre-Covid Levels. The sluggishness may crop into the recovery at the cost of growing inequality. 80% of the informal sector population has felt the burn due to the pandemic and same was the case during demonetization.

The Balance of Payments will likely to be in surplus for the coming few years. However, this may reduce with the rising trade deficit amounts coming from the workplace mobility coming into force and higher oil prices. Even with this, the increased capital inflow coming from asset-monetization, private equity, IPO Funding for start-ups, and inclusions of global bond indices may mean that RBI would continue purchasing dollar for longer adding to liquidity.

The CPI heading Inflation was higher than RBI’s 4% target for 23 months while CPI core inflation was above 4% for 18 months. The cost push inflation showed the elevated energy prices with the prices of coal, crude and gas soaring globally. In India, core CPI has high correlation with the energy prices. The rising prices indicates worries looming over the CPI forecast. Another worry comes with inequality-driven inflation as large companies gain pricing power.

The liquidity is close to 12Trn which higher than FY21 when there was so much uncertainty regarding the pandemic and vaccines. Such high levels of liquidity may cause problems such Asset bubbles, lower returns to depositors (almost negative to pensioners) and striking inequality at firm and individual levels.

Looking at the increased liquidity and inflation, the issues will be addressed at the 8^th October policy meeting. The meeting would focus on liquidity-neutral operation twist actions for OMO bond purchases, hiking reverse repo rate to 3.75% from 3.35%. These hikes would only be followed in H2FY22 and would later be reversed from accommodative to neutral. Hopefully, there would be steps taken by the RBI towards liquidity as well.