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Editorial Today – RBI Monetary Policy

What is Monetary Policy?

  • Monetary policy is the process by which monetary authority of a country, generally a central bank controls the supply of money in the economy by its control over interest rates in order to maintain price stability and achieve high economic growth.
  • In India, the central monetary authority is the Reserve Bank of India (RBI).RBI announces Monetary Policy every year in the Month of April. Earlier, it was  followed by three quarterly Reviews in July, October and January.
  • A panel headed by RBI deputy governor Urjit Patel had recommended that the central bank monetary policy committee meet every two months to review rates.
  • The Reserve Bank of India  shifted to a system of announcing its policy statement bi-monthly with the first such policy being announced on April 1, 2014.
  • Monetary policy of the RBI deals with almost all other vital topics such as financial stability, financial markets, interest rates, credit delivery, regulatory norms, financial inclusion and institutional developments etc.

Highlights of Monetary Policy Review of April:

1) Repo rate cut by 0.25% to 6.50% .

 

  • Repo rate is the rate at which RBI lends to commercial banks generally against government securities.
  • Reduction in Repo rate helps the commercial banks to get money at a cheaper rate and increase in Repo rate discourages the commercial banks to get money as the rate increases and becomes expensive

2) Reverse repo hiked by 0.25% to 6%

 

  • Reverse Repo rate is the rate at which RBI borrows money from the commercial banks.
  • The banks use this facility to deposit their short-term excess funds with the RBI and earn interest on it.

3) Cash reserve ratio or CRR unchanged at 4%

  • Cash Reserve Ratio is a certain percentage of bank deposits which banks are required to keep with RBI in the form of reserves or balances.
  • Higher the CRR with the RBI lower will be the liquidity in the system and vice versa.

4) Minimum daily cash maintenance by banks with RBI cut by 5%

 

  • It is the portion of deposits that banks need to keep with the central bank

5) MSF rate cut by 0.75% to lower banks’ borrowing cost .

 

 

  • To curb the problem of volatility in inter-bank interest rates in the overnight rate, banks are allowed to borrow more funds against G-secs as collateral from the RBI at a rate 100 basis points above the Repo Rate. This is known as Marginal Standing Facility.

6)Policy to remain accommodative going forward

 

  • The RBI has pointed towards better transmission of cuts,and  the policy stance will remain “accommodative”.
  • In other words, more cuts can happen in the year because of following two factors

7) Pegs 2016-17 growth forecast at 7.6%

 

  • Consumer Confidence Survey  shows a marginal improvement in consumer sentiment and the manufacturing purchasing managers’ index reflects a continuing expansion.
  • Survey outcomes — both for industrial and services outlook for the first quarter of the new fiscal year — suggests that business expectations will  remain positive.
  • On the basis of these surveys.  RBI has forecasted 7.6 per cent in gross value added terms for 2016-17.

8) Expects inflation at around 5%

 

  • On the inflation front, the RBI has drawn reassurance from the fact that food inflation eased in the second half of the last financial year, notably as a result of a decline in prices and not as a result of the base effect.
  • The central bank expects retail inflation to continue to decelerate and remain around 5 per cent this year.

9) Cut in small savings rate, MCLR introduction to improve monetary policy transmission

 

  • The cut in the small savings rate in March will incentivise banks to bring down their deposit rates and, as a result, their lending rates.
  • The shift to the “Marginal Cost of Funds-based Lending Rate” mechanism for the banks since April 1 will allow them to charge less on loans since they can base it on the marginal cost of funds instead of the average cost.

10) Government adhering to fiscal consolidation path will help lower inflation

 

  • The lowering of the fiscal deficit target in the Union budget to 3.5% of GDP for fiscal 2017—compared with 3.9% last fiscal year— has had a constructive impact.
  • The RBI has also commended the government on the focus of the budget.
  • The government has also set out a comprehensive strategy for reinvigorating demand in the rural economy, enhancing the economy’s social and physical infrastructure, and improving the environment for doing business and deepening institutional reform.

11) 7th Pay Commission award to put upward pressure of up to 1.5% on inflation

 

  • There will be some pressure on prices once the Seventh Pay Commission and One Rank One Pension awards come through, but for the time being, the RBI does not find a reason to worry.

Aim of the RBI

 

  • RBI’s aim is to help give a monetary fillip to private investment, which is currently becalmed by low capacity utilisation.
  • RBI is convinced that improved monetary transmission holds the key to unlocking credit.
  • It has proposed custodian banks; banks focusing on wholesale and long term financing

Benefits

 

  • The benefits of this prudence will soon be felt in the form of cheaper loans and EMIs.

Second bi-monthly monetary policy on June 7.

 

  • We expect another 25 bps cut from RBI in its June monetary policy review as growth-inflation dynamics improve further.

Road ahead

 

  • The rate cuts of the past 15 months have had an asymmetric and limited impact. How the road ahead is would thus be a function of correcting this anomaly.
  • A  normal monsoon—which seems a likely scenario at this point—will kindle rural demand and balance growth in private consumption. Currently, the economy is firing on only one cylinder—urban demand.
  • Banks will also stoke consumption because of their bias for consumer loans over investments because of higher delinquencies in the latter.
  • That should help improve capacity utilization rates and pave the path for new investments.
  • The upshot is that India’s investment-to-GDP ratio, which has been falling over the past five years, will only mildly revive this fiscal year.

 

 

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  • Yes, Saket, you are right. It has been updated. Thanks for your insights.

  • Saket Bansal

    Right at the beginning of the article, I think its bimonthly policy review instead of quarterly review which has been done away with in the past, Please correct me if i am wrong