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20th April 2024 (18 Topics)

Conditions not ripe for easing restrictive monetary stance

Context

The recent meeting of the Monetary Policy Committee (MPC) highlighted the need to maintain a restrictive monetary stance due to persistent risks to price stability, as outlined by RBI Deputy Governor Michael Debabrata Patra.

Key Highlights of the Meeting
  • Inflation Concerns: Recent inflation data, especially in food prices, indicates ongoing risks. Food inflation, which remained at 8.52% in March, shows resilience, particularly in cereals and meat.
  • Price Momentum: Experts pointed out a build-up of price momentum with rising temperatures as summer approaches, indicating potential challenges until May 2024.
  • Headline Inflation: Despite some disinflation in core areas and fuel, headline inflation might remain on the higher side until favorable base effects kick in during the second quarter of 2024-25.
1: Dimension - Reasons for Maintaining Restrictive Stance
  • Persistent Inflation Risks: The steady core disinflation and fuel price de-escalation do not ensure a quick alignment of headline inflation with the target. Until significant base effects are seen, maintaining a restrictive stance is crucial.
  • Uncertainty in Inflation Trajectory: Experts stressed the importance of maintaining downward pressure on inflation until clearer signs of a durable decline in inflation are evident and uncertainties in the near term are resolved.
2: Dimension - Impact of Loose Monetary Policy
  • Inflationary Pressure: Loose monetary policy could fuel inflationary pressures, particularly with the vulnerability of the inflation trajectory to frequent supply-side shocks, especially in food inflation due to adverse weather conditions.
  • Price Stability Concerns: RBI Governor emphasized the need to remain focused on ensuring durable price stability, highlighting the risks associated with supply-side shocks spilling over into core inflation.
3: Dimension - Required Measures
  • Balancing Growth and Inflation: Any relaxation in the monetary stance should be contingent on a durable decline in inflation and a more balanced risk outlook, ensuring that it doesn't compromise the objective of maintaining price stability.
  • Enhanced Confidence: Experts mentioned that a stronger revival in private consumption and corporate sales growth requires greater confidence in a sustained decline in inflation.

Mains Practice Question

Q: “Inflation remains a persistent challenge despite various measures”. Discuss the factors contributing to this and suggest strategies for effective inflation management.

Key-terms in the monetary policy review

Repo rate

  • Repo rate is an interest rate at which the RBI provides liquidity under the liquidity adjustment facility (LAF) to banks against the collateral of government and other approved securities.
  • Currently, the repo rate is at 6.50 percent.

Standing Deposit Facility (SDF) Rate

  • SDF rate is a rate at which the RBI accepts uncollateralised deposits, on an overnight basis, from banks.
  • The SDF is also a financial stability tool in addition to its role in liquidity management. The SDF rate is placed at 25 basis points below the policy repo rate.
  • Currently, SDF rate is at 6.25 percent.

Marginal Standing Facility (MSF) Rate

  • The penal rate at which banks can borrow, on an overnight basis, from the central bank by dipping into their Statutory Liquidity Ratio (SLR) portfolio up to a predefined limit (2 per cent).
  • MSF rate currently stands at 6.75 percent.

Fine Tuning Operations

  • The main liquidity operation is supported by fine-tuning operations, overnight and/or longer tenor, to tide over any unanticipated liquidity changes during the reserve maintenance period.
  • In addition, the RBI conducts, if needed, longer-term variable rate repo/reverse repo auctions of more than 14 days.

Monetary policy stance

There are various stances:

  • Accommodative Stance, which means the central bank is prepared to expand the money supply to boost economic growth.
  • Neutral stance suggests that the central bank can either cut rate or increase rate. This stance is typically adopted when the policy priority is equal on both inflation and growth.
  • Hawkish stance indicates that the central bank’s top priority is to keep the inflation low. During such a phase, the central bank is willing to hike interest rates to curb money supply and thus reduce the demand.
  • Calibrated tightening means during the current rate cycle, a cut in the repo rate is off the table.

CPI Inflation

  • Consumer Price Index (CPI) based Inflation is a measure of changes in the price levels of goods and services purchased by households.

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