The RBI’s Monetary Policy Committee (MPC) has judiciously chosen to adhere to its goal of ‘ensuring that inflation progressively aligns to the target’ by maintaining benchmark interest rates unchanged and sticking to its ‘withdrawal of accommodation’ stance. With a 5-1 majority, the MPC has committed to maintaining a clearly disinflationary monetary policy to anchor inflation expectations, particularly in the face of ‘large and repetitive price shocks disrupting the pace of disinflation.’
Policymakers must continue to keep the focus on slowing price gains in order to ensure prudence and efficacy of the monetary policy. (10 Marks, 150 Words).
About the Monetary Policy Committee (MPC):
- Monetary policy pertains to the central bank’s strategy in utilizing monetary instruments within its control to achieve the objectives outlined in the Act.
- The primary goal of the RBI’s monetary policy is to uphold price stability, taking into consideration the objective of fostering growth.
- Price stability is deemed a crucial prerequisite for sustainable economic growth.
- The amended RBI Act of 1934 empowers the Government of India, in consultation with the Reserve Bank, to set the inflation target (4% +-2%) once every five years.
Several instruments are employed in monetary policy:
Definition: The interest rate at which the Reserve Bank provides overnight liquidity to banks against the collateral of government and approved securities under the Liquidity Adjustment Facility (LAF).
Reverse Repo Rate:
Definition: The 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.
Liquidity Adjustment Facility (LAF):
Composition: Consists of overnight and term repo auctions.
Purpose: The term repo aims to develop the interbank term money market, establishing market-based benchmarks for loan and deposit pricing to enhance the transmission of monetary policy. Variable interest rate reverse repo auctions are also conducted as needed.
Marginal Standing Facility (MSF):
Description: A facility allowing scheduled commercial banks to borrow an additional amount of overnight money from the Reserve Bank, utilizing their Statutory Liquidity Ratio (SLR) portfolio, subject to a penal rate of interest. It serves as a safety valve against unforeseen liquidity shocks.
Determination: The MSF rate and reverse repo rate set the corridor for the daily movement in the weighted average call money rate.
Definition: The rate at which the RBI is willing to buy or rediscount bills of exchange or other commercial papers. Aligned with the MSF rate, it automatically changes alongside policy repo rate adjustments.
Cash Reserve Ratio (CRR):
Requirement: Mandates banks to maintain an average daily balance with the Reserve Bank as a percentage of their Net demand and time liabilities (NDTL).
Statutory Liquidity Ratio (SLR):
Mandate: Specifies the percentage of NDTL that banks must keep in safe and liquid assets such as unencumbered government securities, cash, and gold. Changes in SLR impact resource availability in the banking system for private sector lending.
Open Market Operations (OMOs):
Function: Encompasses outright purchase and sale of government securities to inject and absorb durable liquidity, respectively.
Market Stabilisation Scheme (MSS):
Introduction: Implemented in 2004 to manage surplus liquidity resulting from prolonged capital inflows. Involves the sale of short-dated government securities and treasury bills, with the mobilized cash held in a separate government account with the RBI.
Rationale Behind the Recent Stance:
- Governor Shaktikanta Das explained the decision to keep the repo rate steady at 6.5% for a sixth consecutive meeting, noting that while domestic economic momentum remained strong, uncertainties in food prices were impacting the headline inflation trajectory.
- The key consideration was the tangible risk that food price pressures could become more widespread and affect broader headline inflation. The majority alignment of the MPC in prioritizing the battle against inflation should be viewed in light of recent trends in retail inflation.
- Despite easing from July’s 15-month peak of 7.4% to 4.87% in October, headline retail inflation rebounded to a four-month high of 5.69% in December.
- Food price gains, measured by the Consumer Food Price Index, surged ahead to 9.53%, a significant increase of 292 basis points compared to October’s 6.61%.
Uncertainty Surrounding Food Prices:
- The recent RBI Bulletin article underscores the growing concern among policymakers regarding the uncertainty surrounding food price increases. The article, titled ‘Are Food Prices the ‘True’ Core of India’s Inflation?’, seeks to address this issue directly.
- The conclusion drawn is that there is sufficient empirical evidence supporting the assertion that ‘there are times when food inflation mimics core inflation.’
- Officials caution that, given the substantial share of food in the consumption basket, significant and repetitive shocks in food prices have the potential to extend outward and jeopardize the objective of price stability by destabilizing inflation expectations.
- The MPC’s decision to downwardly revise its projection for average retail inflation in the January-March quarter to 5.0%, which is 20 basis points lower than its December forecast, reflects the cautious optimism policymakers derive from the improvement in rabi sowing and a seasonal correction in vegetable prices.
The Department of Consumer Affairs’ daily price monitoring dashboard indicates that, as of February 8, the average retail price of over two-thirds of the key food items it tracks remained higher on a year-on-year basis. Policymakers must remain resolute in their commitment to sustainably reduce price increases toward the 4% target to avoid dampening consumption and, consequently, undermining the momentum of economic growth.