RBI’s decisive policy move will help impart stability to markets

News: Recently, the Reserve Bank of India has hiked the policy repo rate by 50 basis points with a unanimous vote for a decisive rate increase, to rein in inflationary pressures which are likely to go beyond the mandated tolerance level.

What are the causes of high inflation?

There is a new ‘globalized inflation’ concept, which is likely to affect future inflation projections.

The Russia-Ukraine War has global effects on many fronts. This has led to rapid migratory patterns, enhanced spending on vitals like food and energy, countries are scrambling for procuring critical raw materials in time at elevated costs, and there are scarcities of fertilizer inputs.

Measures taken by the RBI

Acknowledging inflation

RBI also upped its inflation projections from 5.7% to 6.7% for 2022-23. It has projected crude oil prices to average $105 per barrel. The projection is higher than the market consensus. This clearly indicates that RBI acknowledges the inflation is presenting danger.

At present, the RBI has been anchoring VRRR. This is giving banks better yields on floating deposits while signalling normalization through alignment with market-determined rates.

RBI has shifted from “accommodative” stance to “withdrawal of liquidity” stance to combat inflation.

RBI’s is aligning regulations with global practices to promulgate margin requirements for non-centrally cleared derivative contracts. This should promote the twin objectives of systemic risk reduction and nudging participants to embrace central clearing.

About SDF

Recently, the RBI has introduced the standing deposit facility (SDF) at 3.75%. An SDF operates with no collateral of G-Secs, unlike how the reverse repo system works.

Other macroeconomic situation which supported RBI to hike policy rate in India

Despite global uncertainties, GDP growth numbers continue to inspire optimism. The capacity utilization rates have increased in India, new investment have been announced for the year 2021-22 and India’s manufacturing sector is also leading from the front.

Therefore, RBI has adopted move to for rate hikes and maintaining inflation control as its foremost objective

Way Forward

The Reserve Bank of India (RBI) is going to continue its drive to align policy rates with these stark realities.

The monetary contraction accompanied with fiscal expansion is often ideal for policy coordination to deliver the maximum payoff. Therefore, The RBI Governor has alluded proactive role that fiscal policy can play in unison with monetary policy. For example, states can cut value added tax on fuel.

Over time, the SDF (currently for overnight funds) and VRRR (in multiples of fortnightly durations) are likely to find a dynamic meeting ground.

Additionally, the pragmatic measures should be taken for cooperative banks. It would create a level-playing field, while also giving a fillip to the housing sector and delivery of services at doorsteps.

Our payment infrastructure should be augmented in targeted geographies. For example, RuPay credit cards can be linked with the unified payments interface (UPI).

Source: The post is based on an article “RBI’s decisive policy move will help impart stability to markets” published in the Live Mint on 8^th June 2022.