Economy
Decoding RBI’s monetary policy decisions
Summary
The Reserve Bank of India’s (RBI’s) Monetary Policy Committee (MPC) has kept key policy rates unchanged and introduced a standing deposit facility (SDF), which will be a floor rate. It said a nuanced and nimble approach will be adopted for liquidity management. Mint takes a look:The Reserve Bank of India’s (RBI’s) Monetary Policy Committee (MPC) has kept key policy rates unchanged and introduced a standing deposit facility (SDF), which will be a floor rate. It said a nuanced and nimble approach will be adopted for liquidity management. Mint takes a look:
How is the macro-environment?
Elevated geopolitical tensions, risks of further disruption to stretched global supply chains, and higher input costs due to high commodity and crude oil prices have posed a challenge to countries worldwide, and India is no exception. A US Federal Reserve official has said its interest rate policy has been “behind the curve" and it is ready to raise rates faster to curb inflation. Foreign investors withdrew ₹1.44 trillion from Indian markets in FY22. Domestic consumer demand is slowly showing signs of recovery, and capacity utilization has improved to 72.4%. However, higher domestic inflationary conditions can pose to be a dampener.
What has been the trend in inflation?
Retail inflation in India has been rising since September 2021, touching 6.07% in February 2022, up from 6.01% in January. This is the second consecutive month inflation has crossed RBI’s threshold of 6%. The inflation targeting framework mandates RBI to maintain retail inflation at 4%, plus or minus 2%. Wholesale inflation was 13.11% in February against 12.96% in January. RBI’s challenge is to balance inflation in the economy while supporting the government’s borrowing; that is, keeping sovereign borrowing costs in check and enabling economic growth.
What were the major decisions of the MPC?
The MPC left the repo rate unchanged at 4%, introduced SDF, revised its annual inflation forecast for FY23 to 5.75% from 4.5%, and trimmed gross domestic product (GDP) growth estimate for FY23 to 7.2% (assuming crude oil price at $100 a barrel). But it did mention that the stance would be less accommodative, and there would be a calibrated withdrawal of liquidity.
What is the SDF provided for banks?
At the last meeting, banks were offered a facility to park surplus liquidity through an auctioning system, which was in addition to reverse repo facility. The idea is to suck the surplus liquidity out of the system through the variable reverse repo rate. Now, RBI has regularized the same under the SDF window, which offers 3.75% interest rate for funds parked without any collateral backing. The SDF window will help banks earn a minimum return when they have surplus funds. The SDF rate of 3.75% would be the floor policy rate.
How will RBI’s gradual withdrawal help?
Central banks are supposed to respond to prevailing economic situations appropriately by strategizing through monetary tools. Studies have shown that through these tools, central banks succeed in largely containing demand-pull inflation. Cost-push inflation can be handled only through effective supply management which can be done through appropriate fiscal measures. Thus, venturing into a restrictive policy approach could lead to stagflation.
Jagadish Shettigar and Pooja Misra are faculty members at BIMTECH.
