Monetary Policy of Reserve Bank of India News: The RBI announced its monetary policy review. Details

  • The RBI cut the repo rate by 25 basis points which is the second successive rate cut.
  • It also announced that their policy stance remains neutral as inflation remains below 4%.
Why did the RBI take such a stance?
  • RBI would have considered the inflation forecast for the next year and the monsoon forecast as well.
  • Also RBI believes that the projections are not going to be good for next year.
  • So, the stance remains neutral and not accommodative as expected.
  • There may also be worries about the new government would meet the fiscal deficit given the populist promises given by the political parties.
Monetary policy transmission
  • Monetary policy transmission is the process by which the rate cut made by the RBI is passed on to customers by commercial banks.
  • Presently, commercial banks are not fully passing on the benefits of the rate cut to customers.
  • Capacity utilisation is an important aspect in passing on the rate cut to customers.
  • Presently, manufacturing sector is utilizing only 75% of its capacity. Unless capacity utilisation reaches 80-85% of its capacity, manufacturing sector would not be emboldened to borrow more from the market for further investment.
  • So, though the repo rate might come down it might not actually transfer to more trade flows.
  • Banking sector is burdened with stressed assets due to which it is not able to pass on the rate cut to retail sectors.
Challenges for the government
  1. Management of fiscal deficit and twin deficit problem
  2. Investment plans – Government is the single largest player in the Indian economy. It is to be seen how the government catalyses investments in the infrastructure sector so that demand for investment goes up.
It is also to be seen how the government itself allocates more resources for the capital sector and for building of capacity in the infrastructure sector so that a positive virtuous cycle is created between investment and consumption.
  1. Sterilisation of foreign investment that is expected to flow into the economy in the wake of global slowdown
  2. Addressing the output gap or the deficit.
  • The RBI has raised the inflation forecast for this fiscal – 3.5-3.8% for the second fiscal.
  • Growth forecast has also been lowered from 7.4% to 7.2%.
  • This is due to the chances of abrupt monsoons, abrupt reversal in vegetable prices and unpredictable direction of fuel inflation in the wake of a global slowdown.
  • Food inflation is also another concern which is indicative of farm stress.
  • There is a sharp divergence between core inflation and non-core inflation or the headline inflation.
  • Headline inflation is well within the RBI mandated target of 4% with a allowed divergence of 2% positively or negatively.
  • But core inflation is above 6%.
This divergence could also have influenced the monetary policy stance. February 12 circular
  • It was declared ultravires by the SC recently.
  • It will delay the resolution of stressed assets.
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