rbi-and-monetary-policy-in-india

Context- The Reserve Bank of India’s Monetary Policy Committee (MPC) voted unanimously to leave the policy repo rate unchanged at 4%. .

More on the news

  • Though the economic prospects for 2021- 22 had strengthened with the progress of the vaccination program, but the recent surge in infections had however imparted greater uncertainty to the outlook which needs to be closely watched, especially as localized and regional lockdowns could dampen the recent improvement and demand conditions and delay the return of normalcy.
  • The Monetary Policy Committee, decided to retain the accommodative policy stance by voting unanimously to keep rates steady. 
  • The current focus must be on containing the spread of the virus as well as an economic revival by consolidating the gains achieved so far and sustaining the impulses of growth in the new financial year and a key aspect of this strategy will be to and then the backdrop of macroeconomic stability that has anchored India's revival from the pandemic. 
  • The RBI is optimistic about a pickup in demand and an expansion of business activity this year. 
  • Taking various factors into consideration, the projection of real GDP growth for 2021-22 has been retained at 10.5% consisting of 26.2% in Q1; 8.3% in Q2; 5.4% in Q3; and 6.2% in Q4. 

MONETARY POLICY IN INDIA 

  • The monetary policy of a country is the process of managing the money supply in the economy to achieve specific goals such as constraining inflation, achieving full employment, etc. 
  • It is made by the central Bank of the country and involves various methods like changing interest rates, either directly or indirectly through open market operations, setting reserve requirements or trading in foreign exchange markets. 
  • The monetary policy can be of two types: Expansionary and Contractionary. 
  • Expansionary monetary policy- Such a policy increases the total supply of money in the economy by easing its availability by a relaxation in the rates. In this sense, it can be said that expansionary monetary policy facilitates cheap money supply. Such a policy is used to revive economic growth. 
  • Contractionary monetary policy- Such a policy decreases the total supply of money in the economy by increasing the interest rates and thus making the money dear. Such policies aim to reduce the prices that have gone up due to excessive money supply. 

Monetary Policy Committee (MPC)

  • The government in 2016 amended the RBI Act to constitute a Monetary Policy Committee (MPC) in the Reserve Bank of India, headed by its governor. 
  • It was entrusted with the responsibility of price stability and inflation targeting.
  • The decision was taken in the view of adding value and transparency to monetary policy decisions. 
  • Instruments available to the RBI to achieve the monetary policy ends: Quantitative and Qualitative Quantitative instruments.Quantitative tools 
  1. Bank Rate Policy (BRP): The bank rate refers to the rate at which the central bank (i.e., the RBI) rediscounts bills and prepares commercial banks or provides advance to commercial banks against approved securities.  
  • It is “the standard rate at which the bank is prepared to buy or rediscount bills of exchange or other commercial paper eligible for purchase under the RBI Act”.  If the RBI increases the bank rate, then it reduces the volume of commercial banks borrowing from the RBI and it deters banks from further credit expansion as credit becomes dear. On the other hand, if the RBI reduces the bank rate, borrowing for commercial banks will be easy and cheaper. This will boost the credit creation. 
  • Thus, any change in the bank rate is normally associated withthe resulting changes in the lending rate and in the market rate of interest. 
  1. Repo Rate: The (fixed) interest rate at which the Reserve Bank provides overnight liquidity to banks against the collateral of government and other approved securities under the liquidity adjustment facility (LAF)
  2. Reverse Repo Rate: The (fixed) interest rate at which the Reserve Bank absorbs liquidity, on an overnight basis, from banks against the collateral of eligible government securities under the LAF. 
  3. Open Market Operation (OMO): It refers to the purchase and/or sale of short term and long-term securities by the RBI in the open market.  
  • It is used to wipe out shortages of money in the money market, to influence the term and structure of the interest rate and to stabilize the market for government securities, etc.  
  • If the RBI sells securities in an open market, commercial banks and private individuals buy it and this reduces the existing money supply as money gets transferred from commercial banks to the RBI. 
  • On the other hand, when the RBI buys the securities from commercial banks in the open market, commercial banks get back the money they had invested in them. Through this the stock of money in the economy increases. 

V. Variation in the Reserve Ratios (VRR): The Commercial Banks have to keep a certain proportion of their total assets in the form of Cash Reserves. Some parts of these cash reserves are their total assets in the form of cash.  

  • A part of these cash reserves are also to be kept with the RBI for the purpose of maintaining liquidity and controlling credit in an economy. These reserve ratios are named as Cash Reserve Ratio (CRR) and a Statutory Liquidity Ratio (SLR).  
  • The CRR refers to some percentage of commercial bank’s net demand and time liabilities which commercial banks have to maintain with the central bank.  
  • SLR refers to some percent of reserves to be maintained in the form of gold or foreign securities.   
  • Any change in the VRR brings out a change in commercial banks’ reserves positions.   
  • RBI increases VRR during the inflation to reduce the purchasing power and credit. 

Qualitative Instruments 

  1. Fixing Margin Requirements: It is the “proportion of the loan amount which is not financed by the bank”. A change in a margin implies a change in the loan size. This method is used to encourage credit supply for the needy sector and discourage it for other non-necessary sectors. This can be done by increasing margin for the non-necessary sectors and by reducing it for other needy sectors. 
  2. Consumer Credit Regulation: Under this method, consumer credit supply is regulated through hire purchase and installment sale of consumer goods. This can help in checking the credit use and then inflation in a country.  
  3. Publicity: Through it the RBI publishes various reports stating what is good and what is bad in the system. This information can help commercial banks to direct credit supply in the desired sectors. Through its weekly and monthly bulletins, the information is made public and banks can use it for attaining goals of monetary policy.   
  4. Credit Rationing: Credit is rationed by limiting the amount available for each commercial bank. For certain purposes, the upper limit of credit can be fixed and banks can be told to stick to such limits. This helps in lowering banks credit exposure to unwanted sectors.  
  5. Moral Suasion: It refers to the pressure exerted by RBI on the banks in India without any strict action for compliance of the rules. It helps in restraining credit during inflationary periods. Commercial banks are informed about the expectations of the central bank through a monetary policy. Under moral suasion central banks can issue directives, guidelines and suggestions for commercial banks regarding reducing credit supply for speculative purposes.  
  6. Control Through Directives: Under this method the central bank issues frequent directives to commercial banks. These directives guide commercial banks in framing their lending policy. The RBI issues directives to commercial banks for not lending loans to speculative sectors such as securities, etc. beyond a certain limit.  
  7. Direct Action: Under this method the RBI can impose an action against a bank. If certain banks are not adhering to the RBI’s directives, the RBI may refuse to rediscount their bills and securities. Secondly, RBI may refuse credit supply to those banks whose borrowings are in excess to their capital. Central bank can penalize a bank by changing some rates. Lastly, it can even put a ban on a particular bank if it does not follow its directives and works against the objectives of the monetary policy. 

Significance of Monetary Policy 

  • The monetary policy helps in making money available to the market at reasonable rates and in adequate amounts at the right time to achieve: 
  • Stability in prices 
  • Accelerating the growth of the economy 
  • Exchange rate stabilization 
  • Balancing the savings and investments 
  • Generating full employment 
  • Financial stability of the economy

Conclusion 

Monetary policy changes are aimed at bringing about the desired effects in the growth of the economy through demand management, price management, credit availability, asset prices like stock and real estate and consumption. With the introduction of the monetary Policy Committee (MPC), specialized experience, diversity of views and independence of opinion in the monetary policy decisions will be imparted that can help in improving the representativeness in the overall decision-making process. 

Source- The Hindu

 

Why RBI’s Monetary Policy Committee kept rates unchanged?

Growth vs inflation trade-off

  • The RBI’s decision comes amid a surge in Covid-19 cases that has prompted many states to impose fresh curfew restrictions, triggering concerns over the economic recovery that is underway. 
  • The MPC voted unanimously to keep rates steady and retain the accommodative monetary policy stance.
  • The annual Consumer Price Index-based retail inflation rate rose to a three-month high of 5.03 per cent in February. The MPC judged that monetary policy should remain accommodative till prospects of sustained recovery are well secured. 

Projections on growth and inflation

  • Retail inflation is projected to stay around 5 per cent next year: 5% in Q4 of FY’21; 5.2% in Q1 and Q2 FY’22; down to 4.4% in Q3 FY’22 and 5.1% in Q4 FY’22.The RBI maintained its GDP growth forecast at 10.5 per cent for 2021-22.
    The central bank has slashed the repo rate — benchmark lending rate — by a total of 115 basis points (one basis point is one-hundredth of a percentage point) since March 2020, coming on top of the 135 bps of cumulative cuts since early 2019.