RBI’s Monetary Policy Statement

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    • The Reserve Bank of India held its first bi-monthly monetary policy of 2023-24.

    What is the Monetary Policy Committee?

    • About: 
      • The Monetary Policy Committee (MPC) is a committee of the Central Bank in India (Reserve Bank of India), headed by its Governor, which is entrusted with the task of fixing the benchmark policy interest rate (repo rate) to contain inflation within the specified target level.
      • Under Section 45ZB of the amended RBI Act, 1934, the Union government is empowered to constitute a six-member Monetary Policy Committee (MPC) to determine the policy interest rate required to achieve the inflation target. 
    • Background:
      • MPC was set up consequent to the agreement reached between Government and RBI to task RBI with the responsibility for price stability and inflation targeting. 
      • The Reserve Bank of India and Government of India signed the Monetary Policy Framework Agreement on 20 February 2015.
      • Subsequently, the government, while unveiling the Union Budget for 2016-17 in the Parliament, proposed to amend the Reserve Bank of India (RBI) Act, 1934 for giving a statutory backing to the aforementioned Monetary Policy Framework Agreement and for setting up a Monetary Policy Committee (MPC).
      • The history of suggestions for setting up a MPC is not new and traces back to 2002 when the Y. V. Reddy Committee recommended a MPC to decide policy actions. Subsequently, suggestions were made to set up a MPC in 2006 by the Tarapore Committee, in 2007 by the Percy Mistry Committee, in 2009 by the Raghuram Rajan Committee and then in 2013, both in the report of the Financial Sector Legislative Reforms Commission (FSLRC) and the Dr. Urjit R. Patel (URP) Committee.
    • Composition of MPC:
      • There are a total of six members in the committee, three members are from RBI itself and the rest of them are appointed by the Government of India. 
      • The MPC consists of  six members:
        • RBI Governor (Chairperson)
        • RBI Deputy Governor in charge of monetary policy,
        • One official nominated by the RBI Board 
        • The Government of India will propose three members [committee chaired by the Cabinet Secretary]. 
        • Members of the MPC will serve for four years and are not eligible for reappointment. 
        • The members of the Monetary Policy Committee are appointed for four years. 
    • Functions of the MPCL
      • To target inflation, i.e., to maintain inflation to a certain level (4 % +/- 2%). The Reserve Bank of India (RBI) is responsible for containing inflation targets at 4% (with a deviation of 2%) 
      • Price stability is a necessary precondition to sustainable growth. 
      • To meet the challenges of an increasingly complex economy.

    Key Highlights of the MPC

    • MPC Decision on Interest Rates:
      • The MPC decided to keep the policy repo rate under the liquidity adjustment facility (LAF) unchanged at 6.50%. The standing deposit facility (SDF) rate remains at 6.25%, while the marginal standing facility (MSF) rate and the Bank Rate stay at 6.75%.
      • These decisions aim to align inflation with the medium-term target for consumer price index (CPI) inflation of 4% within a band of +/- 2%, while supporting economic growth.
      • The repo rate is the rate through which the RBI lends money to commercial banks.
    • Global and Domestic Economic Assessments:
      • Global Economy: Global economic activity has been resilient despite high inflation levels, banking system turmoil in some advanced economies, tight financial conditions, and ongoing geopolitical conflicts. Financial stability concerns have led to risk aversion, flights to safety, and increased financial market volatility.
      • Domestic Economy: The RBI’s MPC marginally revised the GDP growth projection upwards to 6.50 per cent for the current financial year of FY 2023-24, from its earlier estimate of 6.4 per cent.
    • Inflation:
      • Headline inflation is moderating, but remains well above the targets of the RBI. These developments have led to heightened volatility in the global financial market. The central bank has projected inflation to marginally decline to 5.2 per cent in FY24.
    • Liquidity and rupee: 
      • India’s current account deficit will remain moderate in Q4 FY23 and also eminently manageable going forward.
      • The RBI will maintain an agile approach for liquidity management to manage the government’s borrowing programme in a non-disruptive manner.

    Conclusion

    • In conclusion, the RBI’s Monetary Policy Statement for 2023-24 maintains a cautious stance, focusing on balancing inflation targets with supporting economic growth. The MPC will continue monitoring the evolving inflation and growth outlook, adjusting policy as needed in future meetings.

    Monetary Policy

    • Monetary policy is adopted by a country to control either the interest rate for a short-term borrowing, such as borrowing by banks from each other for meeting their short-term requirements or the money supply, attempting to decrease inflation or the interest rate, ensuring price stability and general trust of the value and stability of the country’s currency. 
    • The RBI enforces the monetary policy via open market operations, reserve system, credit control policy, bank rate policy, moral persuasion, and numerous other instruments. It’s by using any of these instruments that lead to changes in the interest rate or the money supply in the economy. 

    Types of Monetary Policy 

    • Monetary policies are seen as expansionary or contractionary in nature
    • For example, during times of slowdown or a recession when there’s an increase in money supply and interest rates are reducing, it indicates an expansionary policy. 

    • On the other hand, contractionary monetary policy is the reverse of expansionary policy.

     

    Instruments of Monetary Policy

    • Repo rate (Repurchasing option rate): Commercial banks take loans from the Reserve Bank of India (RBI), by keeping securities with RBI. The RBI then charges the bank with a certain interest rate, that interest rate is commonly known as the Repo rate. This is exactly the same manner in which a bank charges customers interest rates on loans and keeps collateral as security. 
    • Reverse Repo Rate: The difference between the repo rate and reverse repo rate is that here the RBI borrows money from the commercial banks and the bank charges a rate to RBI. If a bank has extra money, it can store it with the RBI for a short period of time. 
    • Standing Deposit Facility (SDF) Rate: The SDF rate is the interest rate that can be charged by banks to RBI when they park their money with RBI. However, in this, the RBI doesn’t issue any collateral, thus, making it easy for commercial banks who have excess securities and don’t want to overburden themselves. SDF rate is higher than the Reverse Repo Rate. 
    • Marginal Standing Facility (MSF) Rate: MSF rate is the interest rate at which the commercial banks can borrow money from the RBI overnight. The loans taken are for emergency circumstances only and saves the bank from volatile situations. MSF rate is always higher than the repo rate. 
    • Liquidity Adjustment Facility (LAF): LAF is the facility which allows the commercial banks to borrow from the RBI or vice versa on a certain repo or reverse repo rate. It is the facility which helps them to manage liquidity. 
    • LAF Corridor: LAF corridor tells the difference between Repo rate and the Reverse Repo Rate. It is the same as the LAF mentioned above. The bank conducts auctions to inject banks with liquidity or to take liquidity from them. 
    • Fine-tuning operations: refer to the process of making small adjustments to a system or process to optimize its performance or achieve a specific goal. This can involve adjusting parameters, testing different configurations, and continuously monitoring and refining the system.
    • Statutory Liquidity Ratio (SLR): It is the amount of funds that banks are required to maintain in the form of liquid assets such as cash, gold, or government securities, as a percentage of their net demand and time liabilities (NDTL). It is a tool used by central banks to regulate the economy by controlling the credit flow in the system.
    • Cash Reserve Ratio (CRR): Cash Reserve Ratio is the minimum amount of liquidity that a bank is supposed to hold. Liquidity is the amount of cash that financial institutions have. The CRR is regulated and imposed by the RBI. 
    • Open Market Operations (OMO): Open Market Operations is how the RBI balances the security and liquidity of banks. If there is excess liquidity, RBI will suck liquidity and release securities, whereas if securities are too high, it will take securities and inject liquidity. 

    Source: IE