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RBI : MPC meet and Monetary policy Implication

RBI is the Central Bank of India, responsible for formulating the Monetary Policy of the country. Along with the Fiscal Policy, Monetary Policy is an important economic and governance tool to shape and direct the Economy of a country. Since the world is going through an economic slowdown on account of Pandemic related disruptions of supply chains, uncertainty in the market, increasing unilateralism, and rising geopolitical threats, the role of Central Banks around the world have become important. RBI is no exception. India is going through an economic slowdown (possibly recession) due to a slump in demand, lower investments, subdued exports, and thin fiscal space of the government, partly due to structural issues like land, labor, etc. and further compounded by the COVID pandemic.

Therefore, the role of RBI becomes an important pillar of the economic response of the government towards this slowdown.

Within the RBI, the Monetary Policy Committee (set up under RBI Act,1934 in 2016) headed by the RBI Governor is responsible for setting up the Monetary policy. The latest meeting of the Monetary Policy Committee took place on Oct 9,2020. RBI continued its expansionary monetary policy with an accommodative stance and would continue to do so as long as necessary. But it kept the Repo Rate unchanged at 4%. The decision was taken unanimously, showing the fact that RBI may hold onto this stance in the coming time. Repo rate is the rate at which RBI lends to the bank in a short term to fulfill immediate liquidity requirements.

When it cuts the Repo rate, the banks are expected to lower their interest rates via Monetary Policy Transmission, creating incentives for borrowers, while increasing the Repo rate is expected to make loans costlier. RBI has cut the repo rate by 115 basis points (bps) since March to provide economic stimulus. But in the latest meet, RBI decided not to cut the repo rate further. This could be explained by the recent Inflation data.

The Wholesale Price Index (WPI) has increased to 1.32%, while the Consumer Price Index (CPI) soared to an 8-month high of 7.3%. RBI has an inflation target band of 2% to 6% with an optimal rate of 4%. Any further rate cut may increase inflationary risks. But RBI expects inflation to settle towards the target band by Q4 of FY21. Also, the Indian banking system has surplus liquidity, so the RBI has decided to keep rates unchanged and focus more on Monetary Policy Transmission.

Apart from this, RBI has kept the Reverse Repo rate unchanged at 3.35%. Reverse Repo rate is the rate at which Banks park their surplus liquidity with RBI. This is a source of earnings for the banks. RBI has consistently reduced the rate to disincentivize parking of liquidity, rather than increase lending. Also, the Marginal Standing Facility and Bank Rate, which are money market instruments for banks to raise short term liquidity, have been kept unchanged at 4.25%. This is an act of balance undertaken by RBI between growth and inflation. Also, a unanimous decision states that RBI is certain about the growth scenario while keeping an eye towards inflation.

RBI has pointed out green shoots in the global and Indian economy. While The global economy appears to have rebounded, but it is not uniform throughout. The investments have remained subdued, but exports and demand levels have improved. This has happened primarily due to fiscal stimulus by countries like the United States, the European Union, Japan, China, India, etc.

But some countries are still under a lockdown or the rate of opening of the economy has slowed due to rising cases, which is affecting their economic recovery. Indian economy is also showing recovery as shown by indicators like increasing sale of tractors (indicative of good agriculture scenario), increasing rural credit, improvement in electricity demand (indicative of improving Manufacturing scenario), improvement in steel consumption and automobile sales, increased freight traffic (indicative of mending of supply chains).

The banking sector aggregates also point towards a mild recovery with improvement in outstanding credit. Purchasing Managers Index (PMI), which is an indicator of business sentiments that has entered into the expansionary territory at 54.6 from contractionary in the preceding month. Both the manufacturing and services components have shown expansion. Also, unemployment has fallen to pre-COVID levels of 6.7% (according to CMIE).

The rural economy has looked resilient. The Kharif sowing has been better than the previous year on account of healthy monsoon. Improved soil moisture conditions and healthy reservoir levels further the prospect of a good Rabi harvest. This can lead to bumper production of food grains in the Fiscal year 2020-21.

The government has taken steps to promote MGNREGA like increasing the labor wages and scheme allocation, providing jobs in rural areas. While the rural migrants have started returning to urban areas to their previous employment. Also, according to NABARD, rural credit has improved. This points to increasing rural demand and an overall improvement in the rural economy.

The inflation scenario also seems optimistic, with inflation expected to be aligned with the target band by Q4 of FY21. The household survey conducted by RBI also charts out eased inflation expectations showing that disruptions in supply chains have been mended. Also, industrial inflation has increased marginally, and PMI data also signals expansion in the Manufacturing and Services sector. The aggregate demand remains slack while crude oil prices are subdued. The food grain and horticulture availability in the country remain at comfortable levels while bumper food grain production is expected after the Kharif and Rabi harvests.

This all contributes to a low inflation scenario. This is a healthy scenario with a growth trajectory that is less inflationary. It clearly points to the high capacity of the economy and the greater space for fiscal expansion. There are sectors like Agriculture, Fast Moving Consumer Goods (FMCG), tractor segment, drugs and pharmaceuticals, electricity especially renewables which have shown recovery, while other sectors are still to recover.

This clearly shows that the recovery is going to be sectoral first, then economy-wide. Hence, policymakers must look towards the primary movers of the economy. The export scenario is bleak with anemic global demand. Also, the pandemic has exposed vulnerabilities of global supply chains, making it a policy imperative to indigenize the essential supply chains. This can affect global trade and exports. Hence the overall projection is a contraction of the economy by 9.5% in the fiscal year 2020-21.

RBI has taken adequate steps towards maintaining target liquidity in the system. It has increased the limits of Ways and Means advances for Centre to 1.25 lakh Cr while increasing the limit for states by 60%. This will ensure adequate short-term fund availability to the respective governments to meet their fiscal obligations. But increased government borrowings can crowd out private sector investors while raising the g-sec yields. This can affect the investment sentiment negatively.

Hence, RBI has opted for Operation Twist to keep g-sec yields down and frequent Open Market Operations (OMOs) to manage liquidity. RBI has also opted on Targeted Long-Term Repo Operations to channel liquidity worth 1 lakh Cr to specific sectors. It has also increased the limit of maximum aggregated retail exposure to one counterparty from 5 lakhs to 7.5 lakhs. Also, RBI has decided to link the risk weights of real estate loans only to the Loan to value ratio, which is expected to give a fillip to this sector.

NBFCs have become an important segment of the financial sector in India due to increased depth and width in the market. They have been rather important in reaching out to the segment, which is untouched by the traditional banking system, thereby promoting financial inclusion. But NBFCs have been facing liquidity crunch since the ILFS crisis, with banks reluctant to extend loans while the financial market (including Mutual funds and commercial papers) has been risking averse.

Recently the RBI announced a co-lending model where banks and NBFCs can collaborate to extend loans. Now RBI has allowed NBFCs including HFCs to take part in this model for priority sector lending. This brings together the comfortable liquidity condition of banks with an efficient and inclusive business model of NBFCs, thereby promoting financial inclusion and inclusive growth.

The RBI has shown activism on the monetary front, with measures taken encompassing all facets of Monetary Policy. Also, the maximum elements of Fiscal Policy measures by the government are credit-based. Therefore, they require a robust and liquid banking system. To move the wheels of the Indian economy, both RBI and the government have unleashed expansionary Fiscal and Monetary policies respectively. The green shoots in the economy are already visible, but still the pandemic is far from over. Also, the structural issues are holding back the economy.

Add to these domestic woes are the global concerns which are creating uncertainty like geopolitics (US-China conflict, West Asian fragility, Sensitive border situation in India, etc.), unilateralism (weakening of WTO mechanisms), climate change negotiations, global protests, and the COVID pandemic related disruptions. Hence, the recovery is imminent, but it is going to be long stretched. Indian economy would stay on Ventilator for some time but is expected to emerge stronger and better.

Award Winning Article Is Written By: Ms.Shivani Rathour

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