Introduction:
Reserve Bank of India has once again raised the repo rate. Monetary Policy Committee on took a unanimous decision to raise benchmark lending rate by 50 basis points to 5.40%. This is the third hike of policy repo rate by RBI this year after 40 basis points hike in May followed by another hike of 50 basis points in June. Pointing out that consumer price inflation or CPI remains uncomfortably high and is expected to remain above 6% RBI Governor Shaktikanta Das said MPC decided to focus on withdrawal of accommodative policy stance to check inflation. He also said domestic economic activity is showing signs of broadening and Bank credit growth has accelerated 14 pc as against 5.5 pc year ago. RBI has also retained its economic growth projection at 7.2 per cent for current fiscal.
Monetary Policy committee:
- It is a statutory and institutionalized framework under the Reserve Bank of India Act, 1934, for maintaining price stability, while keeping in mind the objective of growth.
- The 6-member Monetary Policy Committee (MPC) constituted by the Central Government as per the Section 45ZB of the amended RBI Act, 1934. The first meeting of the Monetary Policy Committee (MPC) was held on in Mumbai on October 3, 2016.
- The Governor of RBI is ex-officio Chairman of the committee. The MPC determines the policy interest rate (repo rate) required to achieve the inflation target (4%).
Monetary Policy objectives:
- It is the macroeconomic policy laid down by the central bank. It involves management of money supply and interest rate and is the demand side economic policy used by the government of a country to achieve macroeconomic objectives like inflation, consumption, growth and liquidity.
- In India, monetary policy of the Reserve Bank of India is aimed at managing the quantity of money in order to meet the requirements of different sectors of the economy and to increase the pace of economic growth.
- The RBI implements the monetary policy through open market operations, bank rate policy, reserve system, credit control policy, moral persuasion and through many other instruments.
Challenges before the RBI:
- When it comes to monetary policy, the RBI’s most important mandate is to maintain price stability.
- To this end, the RBI is required by law to maintain retail inflation which is based on Consumer Price Index (CPI) at the 4% level (with a band of variation of 2 percentage point).
- But, another key concern for the RBI is the overall economic growth in the economy.
- So the challenge before the RBI was to balance the concerns of boosting growth while making sure that inflation does not spiral out of control.
Monetary Policy Instruments and how they are managed?
- Monetary policy instruments are of two types namely qualitative instruments and quantitative instruments.
- The list of quantitative instruments includes Open Market Operations, Bank Rate, Repo Rate, Reverse Repo Rate, Cash Reserve Ratio, Statutory Liquidity Ratio, Marginal standing facility and Liquidity Adjustment Facility (LAF).
- Qualitative Instruments refer to direct action, change in the margin money and moral suasion.
Quantitative Easing for India:
- According to some economists, the only medicine that can work is quantitative easing, a remedy authority isn’t even discussing.
- QE, quantitative easing, may not cure the patient, but it may well succeed in bringing India’s economy out of a coma.
- This kind of QE does have a couple of advantages. One, it lowers the long-term government bond yield.
- That reduces loan costs for risky borrowers, since government bond yields act as a benchmark.
- Two, a more liquid banking system with more low-yielding cash than higher-yielding bonds will be impatient to lend at least in theory.
- Yet this type of QE relies on loans being made. If the demand side of the economy is struggling, the impact may be limited because of the one thing it doesn’t do: lift money supply in the broader economy.
Rising Inflation over a period of time:
Inflation encourages current consumption (buy goods and services now before prices rise) and discourages savings.
- People with savings suffer in times of inflation as the purchasing power of their savings decreases as price levels rise.
- The real rate of interest (nominal rate less the inflation rate) is reduced in times of inflation.
- Real interest rates may be negative if inflation rate is greater than the interest rate. If so the purchasing power of savings declines. This discourages savings.
- People who have borrowed money benefit as the real value of loans decreases as price levels rise (loans are easier to repay in the future as prices and income rise over time).
Conclusion:
- The latest Consumer Price Index data show retail inflation accelerated by almost 100 basis points to a three-month high of 5.03% in February, with food and fuel costs continuing to remain volatile.
- Domestic economic activity is starting to recover with the ebbing of the second wave.
- Looking ahead, agricultural production and rural demand are expected to remain resilient.
- Although investment demand is still anaemic, improving capacity utilisation and congenial monetary and financial conditions are preparing the ground for a long-awaited revival.
