The Monetary Policy Committee (MPC) of the Reserve Bank of India recently raised the benchmark lending rate by 25 basis points (bps) to 6.5%.
GS-III: Indian Economy (Economic Growth and Development in India, Monetary Policy)
Dimensions of the Article:
- RBI’s MPC decision
- Instruments of Monetary Policy
- Monetary Policy Committee (MPC)
- How does the MPC target inflation?
RBI’s MPC decision
- The decision of MPC to raise the lending rate was due to persistently high core or underlying inflation and the RBI, sees it as a risk to the improving outlook for the economy.
- A caliberated monetary policy action is required to keep the inflation expectations anchored, break the persistence of core inflation and thereby strengthen the medium-term growth prospects.
- The MPC, which lowered its CPI inflation forecast for the current fiscal year to 6.5% from the 6.7% it projected at its last policy meeting in December.
- Two of the panel’s six members, however, voted against the majority decision to raise rates.
Instruments of Monetary Policy
There are several direct and indirect instruments that are used for implementing monetary policy.
- 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).
- 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.
- Liquidity Adjustment Facility (LAF): The LAF consists of overnight as well as term repo auctions. Progressively, the Reserve Bank has increased the proportion of liquidity injected under fine-tuning variable rate repo auctions of range of tenors. The aim of term repo is to help develop the inter-bank term money market, which in turn can set market based benchmarks for pricing of loans and deposits, and hence improve transmission of monetary policy. The Reserve Bank also conducts variable interest rate reverse repo auctions, as necessitated under the market conditions.
- Marginal Standing Facility (MSF): A facility under which scheduled commercial banks can borrow additional amount of overnight money from the Reserve Bank by dipping into their Statutory Liquidity Ratio (SLR) portfolio up to a limit at a penal rate of interest. This provides a safety valve against unanticipated liquidity shocks to the banking system.
- Corridor: The MSF rate and reverse repo rate determine the corridor for the daily movement in the weighted average call money rate.
- Bank Rate: It is the rate at which the Reserve Bank is ready to buy or rediscount bills of exchange or other commercial papers. The Bank Rate is published under Section 49 of the Reserve Bank of India Act, 1934. This rate has been aligned to the MSF rate and, therefore, changes automatically as and when the MSF rate changes alongside policy repo rate changes.
- Cash Reserve Ratio (CRR): The average daily balance that a bank is required to maintain with the Reserve Bank as a share of such per cent of its Net demand and time liabilities (NDTL) that the Reserve Bank may notify from time to time in the Gazette of India.
- Statutory Liquidity Ratio (SLR): The share of NDTL that a bank is required to maintain in safe and liquid assets, such as, unencumbered government securities, cash and gold. Changes in SLR often influence the availability of resources in the banking system for lending to the private sector.
- Open Market Operations (OMOs): These include both, outright purchase and sale of government securities, for injection and absorption of durable liquidity, respectively.
- Market Stabilisation Scheme (MSS): This instrument for monetary management was introduced in 2004. Surplus liquidity of a more enduring nature arising from large capital inflows is absorbed through sale of short-dated government securities and treasury bills. The cash so mobilised is held in a separate government account with the Reserve Bank.
Monetary Policy Committee (MPC)
- The Monetary Policy Committee of India is responsible for fixing the benchmark interest rate in India.
- The meetings of the Monetary Policy Committee are held at least 4 times a year and it publishes its decisions after each such meeting.
- The committee comprises six members – three officials of the Reserve Bank of India and three external members nominated by the Government of India.
- They need to observe a “silent period” seven days before and after the rate decision for “utmost confidentiality”.
- The Governor of Reserve Bank of India is the chairperson ex officio of the committee.
- The Reserve Bank of India Act, 1934 was amended by Finance Act (India), 2016 to constitute MPC which will bring more transparency and accountability in fixing India’s Monetary Policy.
- The monetary policy are published after every meeting with each member explaining his opinions.
- The committee is answerable to the Government of India if the inflation exceeds the range prescribed for three consecutive months.
- Key decisions pertaining to benchmark interest rates used to be taken by the Governor of Reserve Bank of India alone prior to the establishment of the committee.
- The Governor of RBI is appointed and can be disqualified by the Government anytime.
How does the MPC target inflation?
- Every two months, the Reserve Bank’s MPC has a review meeting where they discuss the likely inflation and growth estimates over the coming months.
- Based on this review, the MPC targets inflation using the policy rate, or the repo rate. When inflation is higher than the inflation target set by the central bank, then the MPC must increase the repo rate. On the other hand, when the actual inflation is lower than the target, the MPC could decrease the repo rate. The
- MPC looks at consumer price inflation (CPI) as the inflation target that it must keep between 2% and 6%.
-Source: The Hindu