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RBI Monetary Policy

Feb 14, 2022

RBI Monetary Policy

RBI Monetary policy is one of the essential topics of the Economy subject of UPSC Civil Services exam and should be carefully studied during the UPSC exam preparation. Monetary Policy Committee (Composition, Objectives, and Functions), Policy rates, Factors affecting Monetary Policy are interlinked with the RBI Monetary policy.

Why in the News?

The Reserve Bank of India's Monetary policy committee kept the policy interest rates unchanged and continued the accommodative stance on its Monetary policy.

Probable Question

RBI's Monetary Policy stances are indicators of the state of the economy. Comment.

Key Points

● Current Monetary Policy Rates:

○ Repo Rate: 4%

○ Reverse Repo rate: 3.35%

○ Marginal Standing Facility (MSF): 4.25%.

○ Bank Rate: 4.25%.

Adopting Accommodative Stance: The Monetary Policy Committee has decided to continue with the accommodative stance to ensure the economy's recovery from the COVID19 pandemic becomes durable and broad-based.

○ An accommodative stance means a central bank will cut rates to inject money into the financial system whenever needed

GDP Growth Projection: The RBI expects the economic growth to be 7.8 per cent in 2022-23, down from 9.2 per cent in the ongoing financial year.

○ In comparison, the IMF has pegged growth at 9 percent next year, while the Economic Survey expects it to range between 8-8.5 percent.

RBI On Cryptocurrency: The RBI stated that private cryptocurrencies are a big threat to our financial and microeconomic stability. They will undermine RBI's ability to deal with issues related to financial stability.

● Recently the government has proposed a 30 percent tax on private cryptocurrency and non-fungible tokens.

● RBI has also extended the on-tab liquidity schemes to contact-intensive sectors which will allow them to get access to credit at slightly lower rates.

Factor Affecting RBI's Monetary Policy

There are several factors that affect RBI Monetary Policy. 

Consumer Price Index (Inflation): Higher CPI means people have more money than they are required. If inflation is extremely high RBI will increase the rate of Interest.

● Strength of Financial Sectors: If banks in the country are functioning in a better manner, or when the transition of policy interest rate from RBI to the consumer is smooth and banks are not finding any difficulty to charge higher or lower. RBI will keep their policy interest rate accommodative.

Balance of Payment (BoP): Higher negative Balance of Payment shows people are importing more and exporting less, it simply means people have more money to spend than required. In this case, the RBI will increase the interest rate.

Employment Generation: If employment generation is low, RBI will reduce the rate of interest to increase the money supply in the economy to generate employment.

Forex conditions: If India's currency is depreciating, RBI will interfere by changing their policy rate to control the supply and demand of the currency.

Seasonal shocks: For example, in agriculture, Higher agriculture production means higher industrial production, which simply means that the government and RBI go on the easy policy rate either they can reduce the policy rate or go with the same.

Fiscal status of the government: If the fiscal deficit is extremely high and the government is planning to raise money from the market, RBI will change the policy rate in order to provide easy money to the government.

Core Sector Growth: If the eight core sector industries are registering low growth rate which is indicated by the IIP (Index of Industrial Production), means RBI has to reduce the policy rate to improve the money supply in the economy.

Watch a detailed video on Personal Income Tax by Vivek Singh Sir, one of our educators of the DREAM TEAM for UPSC and become a Pro in Economy:

Policy Stances of the MPC

Accommodative: An accommodative stance means the central bank is prepared to expand the money supply to boost economic growth. The central bank, during an accommodative policy period, is willing to cut the interest rates. A rate hike is ruled out.

○ The Reserve Bank of India (RBI) has been on an accommodative stance for the last two years to support the economy during the COVID-19 crisis.

Neutral: A 'neutral stance' suggests that the central bank can either cut-rate or increase the rate.

○ The interest rate can move to either side depending on incoming data.

Hawkish: A hawkish stance indicates that the central bank's top priority is to keep inflation low.

○ During such a phase, the central bank is willing to hike interest rates to curb the money supply and thus reduce the demand. A hawkish policy also indicates a tight monetary policy.

Calibrated Tightening: Calibrated tightening means during the current rate cycle, a cut in the repo rate is off the table. But the rate hike will happen in a calibrated manner.

○ This means the central bank may not go for a rate increase in every policy meeting, but the overall policy stance is tilted towards a rate hike.

 Also read: Best Way to Prepare Economy for UPSC Prelims

About Monetary Policy

● Monetary policy is the macroeconomic policy laid down by the Central bank.

● It involves the management of money supply and interest rate and is the demand side economic policy used by the government of a country to achieve macroeconomic objectives inflation, consumption, growth and liquidity.

Urjit Patel committee in 2014 recommended the establishment of the Monetary Policy Committee.

● It is a statutory and institutionalized framework under the Reserve Bank of India Act, 1934, for maintaining price stability, while keeping in mind the objective of growth.

● Composition: Six members (including the Chairman) – three officials of the RBI and three external members nominated by the Government of India.

○ The Governor of RBI is ex-officio Chairman of the committee

● Functions: The MPC determines the policy interest rate (repo rate) required to achieve the inflation target (presently 4%).

Key Terms related to Monetary Policy

Repo Rate:

● Repo rate is the rate at which the central bank of a country (Reserve Bank of India in case of India) lends money to commercial banks in the event of any shortfall of funds.

● It is used by monetary authorities to control inflation.

Reverse Repo Rate:

● This is the rate at which the Central bank of a country (RBI) borrows money from commercial banks.

● It is generally lower than the repo rate, at any point of time.

● It is used to control cash flow in the market

Marginal Standing Facility:

● MSF or marginal standing facility is a system of the Reserve Bank of India that allows scheduled commercial banks to avail funds overnight.

● The interest rate charged by RBI on such borrowings is called the MSF rate or marginal standing facility rate.

Bank Rate:

● It is the rate at which the RBI is ready to buy or rediscount bills of exchange or other commercial papers.

Cash Reserve Ratio (CRR):

● CRR is the average daily balance that a bank is required to maintain with the RBI as a share of such percent of its net demand and time liabilities (NDTL) that the RBI may notify from time to time in the Gazette of India.

 Open Market Operations:

● Open Market Operations include both, outright purchase and sale of government securities, for injection and absorption of durable liquidity, respectively.

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