RBI’s Monetary Policy Review

Context

Recently the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) unveiled its latest review of the monetary policy.

Probable Question

Explain RBI's Monetary Policy Committee's role, significance, and functioning in controlling Inflation in Indian Economy. (150 words, 10 marks)

About Monetary Policy Committee

• Section 45ZB of the amended RBI Act, 1934 provides for an empowered six-member monetary policy committee (MPC).
• Formation: 
  • The monetary policy committee is to be constituted by the Central Government by notification in the Official Gazette. 
  • The first such MPC was constituted on September 29, 2016. 
• Objective: The MPC determines the policy repo rate required to achieve the inflation target.
• Composition: As per Section 45ZB of the amended RBI Act, 1934, MPC shall consist of 6 members.
• Working:
  • The MPC is required to meet at least four times a year. The quorum for the meeting of the MPC is four members.
  • The decision of the MPC shall be final and binding on the banks.

Instruments of Monetary Policy

• Repo Rate: The interest rate at which the Reserve Bank provides liquidity to commercial banks.
• Standing Deposit Facility (SDF) Rate: The rate at which the Reserve Bank accepts uncollateralized deposits, on an overnight basis, from all LAF participants.
• Marginal Standing Facility (MSF) Rate: The penal rate at which banks can borrow, from the Reserve Bank on an overnight basis.
• Liquidity Adjustment Facility (LAF): The LAF refers to the Reserve Bank’s operations through which it injects/absorbs liquidity into/from the banking system.
• LAF Corridor: The LAF corridor has the marginal standing facility (MSF) rate.
• Main Liquidity Management Tool: A 14-day term repo/reverse repo auction operation.
• Fine Tuning Operations: The main liquidity operation is supported by fine-tuning operations.
• Reverse Repo Rate: The interest rate at which the Reserve Bank absorbs liquidity from banks.
• Bank Rate: The rate at which the Reserve Bank is ready to buy or rediscount bills of exchange or other commercial papers.
• Cash Reserve Ratio (CRR): The average daily balance that a bank is required to maintain with the Reserve Bank.
• Statutory Liquidity Ratio (SLR): Every bank shall maintain in India assets, the value of which shall not be less than such percentage of the total of its demand and time liabilities.
• Open Market Operations (OMOs): These include the outright purchase/sale of government securities by the Reserve Bank for injection/absorption of durable liquidity in the banking system.

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About the need for monetary policy reviews

• Typically when an economy experiences fast economic growth, there is a lot of demand in the economy that leads to a rise in prices (inflation).
• Some degree of inflation is desirable as it promotes economic activity.
• When inflation runs high, RBI raises the repo rate. Doing this incentivizes savings and disincentives expenditure, thus curtailing overall demand and GDP. That, in turn, reduces the inflation rate.
• In times of weak economic activity, RBI cuts the repo rate and by the reverse logic, boosts demand and economic output.
• All these critical decisions about the repo rate are taken by the MPC, which meets once every two months to assess inflation and growth outlook.
• The Reserve Bank’s Monetary Policy Department (MPD) assists the MPC in formulating monetary policy.
• The monetary policy maintains price stability while keeping in mind the objective of growth.

Significance of the latest policy review

• The severe growth slowdown that India is facing before, amid and post-pandemic has got worse and Russia’s war in Ukraine has made the situation even worse.
• RBI has prioritized economic recovery but that has meant high inflation, which hurts the poor the most.
• Since the start of 2022, inflation has been above the 6% mark. The RBI has had to explain to the government why it let this happen.

Highlights of the latest Monetary Policy Review

• Policy repo rate: It is raised by 35 basis points (bps, a 100bps equals 1% point) to 6.25%.
• GDP: It has scaled-down GDP growth hopes for the year to 6.8% from 7%. Real GDP growth is projected at 7.1% for Q1 of 2023-24 and at 5.9% for Q2. 
• Inflation: The central bank retained its inflation projection for 2022-23 at 6.7%, which is above the 6% upper tolerance limit set for the RBI (4% is the target).
• Risk: The biggest risks to the outlook continue to be the headwinds emanating from protracted geopolitical tensions, global slowdown, and tightening of global financial conditions. 
• Overall report: The monetary policy projected that despite everything, India will still be among the fastest-growing major economies in the world.

Way Forward

• We must deal with the current global hurricane with confidence and endurance.
• The central bank must first “shepherd inflation firmly into the tolerance band (below 6%) and then to the 4% target”.
• India is decoupled from the global economy in several aspects, it cannot be entirely decoupled in an inter-connected world.

News Source: The Indian Express

https://indianexpress.com/article/explained/reading-rbis-monetary-policy-review-8312181/

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