RBI's Latest Monetary Policy Announcement on Repo Rate

Context: Since the April monetary policy, the Reserve Bank of India (RBI) has maintained the repo rate at 6.5 percent, following a 250 basis points (bps) increase starting from May 2022. This decision was prompted by signs of moderating inflation. In the upcoming December Monetary Policy, the Monetary Policy Committee (MPC) is likely to retain the repo rate at 6.5 percent due to escalating inflationary risks, particularly attributed to a recent surge in vegetable prices.

Overview of Recent Economic Indicators:

1. Consumer Price-based Inflation (CPI):

   • In October, CPI eased to 4.87% from 5.02% in September.

   • Despite the decrease, retail inflation remains above the RBI's 4% target.

2. Q2FY’24 GDP Growth:

   • GDP growth for Q2FY’24 exceeded the estimated 6.5%.

   • This may lead RBI to slightly revise its FY2024 growth forecast upwards.

   • The projected real GDP growth for FY’24 is currently at 6.5%.

3. RBI's Inflation Forecast:

   • Despite the positive growth outlook, RBI is unlikely to change its headline inflation forecast.

   • The forecast remains at 5.4% for the current fiscal year.

Understanding Inflation

1. Definition of Inflation:

   • Inflation is the sustained increase in the general price level of goods and services, reducing money's purchasing power over time.

2. Types of Inflation:

   • Headline Inflation: Total inflation for a period, including a basket of commodities like food and fuel in India.

   • Core Inflation: Calculated by excluding volatile goods like food and fuel (Core Inflation = Headline Inflation – Food and Fuel Inflation).

3. Inflation Targeting:

   • It's a monetary policy framework aiming to maintain a specific inflation target range.

   • The Urjit Patel Committee recommended using CPI over WPI for this purpose.

   • The current target is 4% with a +/- 2% acceptable deviation range, set by the government in consultation with RBI.

4. Liquidity:

   • Refers to the ease of buying or selling an asset without significantly impacting its price.

   • Indicates the availability of cash or liquid assets for financial obligations or investments.

RBI’s Monetary Policy Committee (MPC)

1. Establishment and Basis:

   • Established under the RBI Act, 1934 amendment in May 2016.

   • Provides a statutory basis for the flexible inflation targeting framework.

2. Inflation Target Determination:

   • Set by the Central Government in consultation with RBI every five years under Section 45ZA.

   • The target from August 5, 2016, to March 31, 2021, was 4% CPI inflation with 6% and 2% upper and lower limits, respectively.

   • Retained the same target and band for April 1, 2021, to March 31, 2026.

3. Composition and Role of MPC:

   • A six-member committee established under Section 45ZB of the RBI Act.

   • Responsible for determining the policy rate to achieve the inflation target.

   • Meets at least four times a year; quorum is four members.

   • Members include RBI Governor (Chairperson), RBI Deputy Governor, one RBI officer, and three government representatives.

4. Reporting and Transparency:

   • Required to publish a Monetary Policy Report every six months explaining inflation sources and forecasts.

RBI's Response to Inflation Target Deviation

Reporting in Case of Failure:

• If the inflation target is not met, RBI must submit a report to the Central Government with reasons, remedial actions, and a timeline for achieving the target.

Monetary Policy Instruments

1. Repo Rate and Other Rates:

   • Repo Rate: Rate at which RBI provides liquidity against collateral.

   • Standing Deposit Facility (SDF) Rate: Rate for accepting uncollateralized deposits, 25 basis points below the repo rate.

   • Marginal Standing Facility (MSF) Rate: Penal rate for banks to borrow, 25 basis points above the repo rate.

2. Liquidity Management:

   • Liquidity Adjustment Facility (LAF): Operations to manage banking system liquidity.

   • LAF Corridor: Defined by the MSF rate (upper bound) and the SDF rate (lower bound).

3. Additional Tools:

   • Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR): Mandatory bank reserves.

   • Open Market Operations (OMOs): Purchase/sale of government securities for liquidity management.

Way Forward with Repo Rate at 6.5%

1. Inflation Control and Economic Support:

   • Monitor inflation trends and implement measures to control inflation.

   • Support economic growth through fiscal and policy measures, and encourage private investment.

2. Banking Sector and Investment Strategies:

   • Adjust bank interest rates, strengthen risk management, and re-evaluate investment portfolios.

3. Communication and Global Trends:

   • Maintain transparent communication and monitor global economic indicators.

4. Focus on Financial Inclusion and Digitalization:

   • Enhance financial inclusion and leverage digital platforms.

5. Fiscal Policy Coordination and SME Support:

   • Coordinate fiscal policies and provide support to SMEs.

6. Continual Assessment:

   • Regularly assess the impact of repo rate changes and adjust policies as needed.