Monetary Policy

What’s in today’s article?

• Why in News?
• What is Monetary Policy?
• What is the Monetary Policy Committee (MPC)?
• What are the Instruments of Monetary Policy?
• Why is the RBI in Pause Mode?
• What will Happen to Lending, Deposit Rates?
• What are the Risks Ahead?

Why in News?

• With retail inflation remaining a major risk to macroeconomic stability and sustainable growth, the 6-member Monetary Policy Committee (MPC) of the RB) has decided to keep the key interest rates unchanged for the 4th consecutive time.
• As a result, banks will not raise their lending rates, which means that the equated monthly instalments (EMIs) on home, vehicle and personal loans will remain steady.

What is Monetary Policy?

• Meaning: It is the demand side economic policy used to achieve macroeconomic objectives like inflation, consumption, growth and liquidity.
• Monetary policy in India:
  • In India, the monetary policy of the RBI 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.
    • For example, liquidity is crucial to stimulate growth for an economy. The RBI depends on monetary policy to maintain liquidity.
  • The RBI implements the monetary policy through open market operations (OMOs), bank rate policy, reserve system, credit control policy, moral persuasion, etc.
    • For example, the RBI introduces the money in the economy and cuts the interest rate by buying bonds through OMOs.
  • The use of any of these tools will result in adjustments in interest rate or the money supply in the economy.

Classification of Monetary Policy

Monetary policy can be classified as expansionary (or accommodative) and contractionary (or tight) in nature.

• Accommodative monetary policy is triggered to encourage more spending from consumers and businesses by increasing money supply and reducing interest rates.
  • When firms can easily borrow money, they have more funds to expand operations and hire more workers, resulting in a lower unemployment rate.
  • On the other hand, if the money supply is loosened over an extended period of time, there will be too much money chasing too few goods and services, resulting in inflation.
• To avoid inflation, most central banks rotate between accommodating and tight monetary policy (decreasing the money supply and raising interest rates) to varied degrees in order to promote growth while keeping inflation under control.

What is the Monetary Policy Committee (MPC)?

• The Reserve Bank of India (RBI) Act, 1934 was amended by the Finance Act, 2016 to constitute MPC.
• MPC is responsible for fixing the benchmark interest rate in India, bringing more transparency and accountability in fixing India's Monetary Policy.
• The committee comprises six members - three officials of the RBI and three external members nominated by the Government of India (GoI). The RBI Governor is the chairperson (ex officio) of the committee.
• The current mandate of the committee is to maintain 4% (+/- 2%) annual consumer price index-based inflation (CPI) rate and the committee is answerable to the GoI if the inflation exceeds the range prescribed for three consecutive quarters.

What are the Instruments of Monetary Policy?

Why is the RBI in Pause Mode?

• While the MPC has retained the policy stance as ‘withdrawal of accommodation’ in a majority 5:1 decision, it has also retained the inflation projection at 5.4% for FY2024 in the wake of the high food inflation
  • While retaining the GDP growth at 6.50% for FY2024, the policy panel signals that a rate cut is unlikely in the near future.
  • The RBI has focused on its stance of ‘withdrawal of accommodation’ until all risks to inflation dissipate.
  • Withdrawal of accommodation will mean reducing the money supply in the system which will rein in inflation further.
• The pause in the Repo rate - the rate at which RBI lends money to banks to meet their short-term funding needs - is because the overall inflation outlook is clouded by uncertainty by
  • The fall in kharif sowing,
  • Lower reservoir levels,
  • Volatile global food and energy prices.

What will Happen to Lending, Deposit Rates?

• As the RBI has kept the policy rate unchanged, all external benchmark lending rates (EBLR) linked to the repo rate will not rise.
  • Notably, EBLRs - 81% of which are linked to the benchmark repo rate - now dominate the mix of outstanding floating rate loans.
• It will provide some relief to borrowers as their equated monthly instalments (EMIs) will not increase.
• Banks will also not increase fixed deposit rates in the wake of the pause in Repo rate.
  • The decision to hold deposit rates at the current levels will be driven by surplus liquidity in the banking system.
  • This is due to improvement in low-cost current account and savings account (CASA) balance (Rs 3.42 lakh crore) following the deposit of Rs 2000 banknotes.

What are the Risks Ahead?

• The RBI panel met against a backdrop of growing domestic as well as external economic challenges.
• These domestic challenges encompass growing risks to consumption demand amid high food inflation, an uneven monsoon adversely affecting kharif crops and higher interest rates.
  • Retail inflation eased to 6.83% in August from a 15-month high of 7.44% in July, however, it continues to remain above the RBI’s comfort zone of 2-%.
• The recent spike in crude oil prices (sitting above $85 per barrel) and global bond yields will keep MPC vigilant on inflation-growth dynamics.

Q.1) What is the meaning of the Bank Rate?

The Bank Rate is the quantitative instrument of RBI’s monetary policy, which acts as the penal rate charged on banks for shortfalls in meeting their reserve requirements - cash reserve ratio and statutory liquidity ratio.

Q.2) What is the meaning of the Open Market Operations (OMOs)?

OMOs is the quantitative instrument of RBI’s monetary policy, which include outright purchase/sale of government securities by the RBI for injection/absorption of durable liquidity in the banking system.

Source: RBI’s status quo and an indication that rate cuts would have to wait: What’s in store for borrowers, depositors | IE