Source: The Hindu
- Prelims: Current events of national importance, RBI, Inflation, MPC.
- Mains GS Paper III: Indian Economy and issues relating to Planning, Mobilization of Resources, Growth, Development and Employment(Inflation, Monetary policy).
ARTICLE HIGHLIGHTS
- The Reserve Bank of India (RBI) has pitched to ‘keep inflation and inflationary expectations under check’ front and centre of its policy approach.
- The Reserve Bank of India (RBI) increased the repo rate by 50 basis points to 4.90%. The earlier repo rate was 4.40% after the rates were increased by 40 basis points at an off-cycle meeting of the Monetary Policy Committee.
- The Standing Deposit Facility and Marginal Standing Facility rates also raised by 50 basis points. Standing Deposit Facility rate is now 4.65 per cent, while Marginal Standing Facility rate is at 5.15 percent.
- MPC now projects retail inflation to average 6.7% over the entire fiscal year ending in March, a fullone percentage point increase from the 5.7% it forecast in April.
INSIGHTS ON THE ISSUE
Context
Inflation:
- Inflation refers to the rise in the prices of most goods and services of daily or common use, such as food, clothing, housing, recreation, transport, consumer staples, etc.
- Inflation measures the average price change in a basket of commodities and services over time.
- The opposite and rare fall in the price index of this basket of items is called ‘deflation’.
- Inflation is indicative of the decrease in the purchasing power of a unit of a country’s currency.
- RBI through its Monetary Policy Committee(MPC) Controls Inflation with its tools to control Money supply in the market.
- Inflation is measured by a central government authority, which is in charge of adopting measures to ensure the smooth running of the economy. In India, the Ministry of Statistics and Programme Implementation measures inflation.
- Inflation is primarily measured by two main indices — WPI (Wholesale Price Index) and CPI (Consumer Price Index), which measure wholesale and retail-level price changes, respectively.
Two types of inflation:
- Demand Pull Inflation: Demand pull inflation arises when aggregate demand in the economy becomes more than aggregate supply.
- Cost push inflation: when there is a decrease in aggregate supply of goods and services results in an increase in cost of production.
Reasons for Increasing Inflation in India:
- Inflation in India cannot be described just as ‘cost-push’. Abundance of liquidity has been an important factor. The April Monetary Policy statement talked of a liquidity overhang of the order of ₹8.5 lakh crore.
- Rise in prices of crude petroleum and natural gas, mineral oils, basic metals, etc. owing to disruption in the global supply chain caused by the Russia-Ukraine conflict.
- Retail inflation rose mainly on account of rising prices of essential food items like ‘oils and fats’, vegetables and protein-rich items such as ‘meat and fish’.
- The sharp rise in commodity prices across the world is a major reason behind the inflation spike in India. This is increasing the import cost for some of the crucial consumables, pushing inflation higher.
Impact of Higher Inflation in India:
- It is expected to push up interest rates in the banking system.
- Equated Monthly Installments (EMIs) on home, vehicle and other personal and corporate loans are likely to go up.
- Deposit rates, mainly fixed term rates, are also set to rise.
- Consumption and demand can be impacted by the Repo rate hike.
- The hike in CRR will suck out a large amount of money from the banking system. The lendable resources of banks will come down accordingly.
- It also means the cost of funds will go up and banks’ net interest margins could get adversely impacted.
Challenges in Tackling Increasing Inflation:
- The borrowing programme will increase, and additional liquidity support may be required.
- For a rise in the interest rate to stick, appropriate actions must be taken to contract liquidity. That is what the rise in CRR will do. In the absence of a rise in CRR, liquidity will have to be sucked by open market operations.
- Liquidity conditions need to be modulated in line with the policy action and stance to ensure their full and efficient transmission to the rest of the economy.”
Steps taken by MPC:
- The Reserve Bank of India (RBI) increased the repo rate by 50 basis points to 4.90%. The earlier repo rate was 4.40% after the rates were increased by 40 basis points at an off-cycle meeting of the Monetary Policy Committee.
- The RBI also revised the inflation projection for FY23 to 6.7 percent from 5.7 percent earlier.
- The RBI also left its FY23 GDP growth forecast unchanged at 7.2%.
- The Standing Deposit Facility and Marginal Standing Facility rates were also raised by 50 basis points.
- Standing Deposit Facility rate is now 4.65 per cent, while Marginal Standing Facility rate is at 5.15 percent.
Impact of Changing rates:
- The Repo rate hike will force banks and non-banking finance companies to increase repo-linked lending rates and minimum cost of funds based lending rates (MCLR) This is because the cost of funds of banks will rise with the Repo rate hike.
- The net result will be a further rise in equated monthly installments (EMIs) of existing borrowers. Moreover, new home, vehicle and personal loans will also become costlier.
- Consumption and demand can be impacted by the Repo rate hike.
- Banks will also have to increase the deposit rates in the coming months.
| Repo rate
It is the interest charged by the RBI when commercial banks borrow from them by selling their securities to the central bank. Essentially it is the interest charged by the RBI when banks borrow from them – much like commercial banks charge you interest for a car loan or home loan. Cash Reserve Ratio (CRR) commercial banks have to hold a certain minimum amount of deposit as reserves with the central bank. The percentage of cash required to be kept in reserves as against the bank’s total deposits is called the Cash Reserve Ratio. Marginal Standing Facility: ● MSF is a window for scheduled banks to borrow overnight from the RBI in an emergency situation when interbank liquidity dries up completely. ● Under interbank lending, banks lend funds to one another for a specified term. Differences between Repo Rate and MSF: ● Repo rate is the rate at which RBI lends money to commercial banks, while MSF is a rate at which RBI lends money to scheduled banks. ● The repo rate is given to banks that are looking to meet their short-term financial needs. The MSF is meant for lending overnight to banks. ● Lending at repo rates involves a repurchase agreement of securities. While it is not so in MSF. ● Under MSF, banks are also allowed to use the securities that come under Statutory Liquidity Ratio (SLR) in the process of availing loans from RBI. ● Under SLR, commercial banks are mandated by RBI to maintain a stipulated proportion of their deposits in the form of liquid assets like cash, gold and unencumbered (free from debt) securities. Monetary Policy Committee (MPC) ● Under RBI Act, 1934, the central government is empowered to constitute a six-member Monetary Policy Committee (MPC). ● It shall determine the Policy Rate required to achieve the inflation target”. ● The decision of the Monetary Policy Committee shall be binding on the Bank. ● Composition: consists of 6 members: 1. RBI Governor as its ex officio chairperson, 2. Deputy Governor in charge of monetary policy, 3. An officer of the Bank to be nominated by the Central Board, 4. Three persons to be appointed by the central government. ● This category of appointments must be from “persons of ability, integrity and standing, having knowledge and experience in the field of economics or banking or finance or monetary policy”. |
Way Forward
- As the RBI Governor put it in his statement, “Liquidity conditions need to be modulated in line with the policy action and stance to ensure their full and efficient transmission to the rest of the economy.”
- To contain inflation on food prices, crackdown on supply side if hoarding happens and ease import limits on pulses, oil seed.
- Prepare to use buffer stock if inflation spills over to cereals, 1% rise in WPI primary food prices can go up CPI by 48 bps.
- Press for faster growth, 10% higher industrial output can ease retail inflation by 40 bps along with addressing supply bottlenecks.
- Boost income generating capacity to reduce burden on low income households
QUESTION FOR PRACTICE
RBI keeps inflation and inflationary expectations under check, front and centre of its policy approach. Discuss. (200 WORDS, 10 MARKS)
