The counterfactual to monetary policy status quo in Dec-21 could have been a token hike in reverse repo rate as espoused by Mridul Saggar and Ashima Goyal along with Jayantha Varma, who has been vocal on the need for scaling back emergency level policy accommodation on diminishing economic effects of the pandemic. Such an outturn appears to have implicit approval from the RBI as the recourse to VRRR auction saw an expansion in scope and coverage in the Dec-21 policy review. The share of overnight liquidity in total liquidity has dropped to ~15% from ~23% prior to the Dec-21 policy review - this will drop further as the RBI intends to calibrate liquidity surplus predominantly via the auction route starting Jan-22. With weighted average VRRR auction cut-offs holding at 3.98% currently, i.e., close to the repo rate at 4.00% rather than the reverse repo rate of 3.35%, short term money market rates could firm up further from current levels. This will make the case for formal interest rate normalization stronger. If Omicron risks stay subdued, we expect RBI to bite the bullet with a 40 bps hike in the reverse repo rate, spread evenly between Feb-22 and Apr-22.
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