Monetary Policy: RBI takes charge
Monetary Policy: RBI takes charge*
M G Warrier
PREAMBLE of the Reserve Bank of India mandates the central bank
“to regulate the issue of Bank notes and the keeping of reserves with a view to securing monetary stability in 2 [India] and generally to operate the currency and credit system of the country to its advantage”
Prior to the establishment of the Reserve Bank, the Indian financial system was totally inadequate on account of the inherent weakness of the dual control of currency by the Central Government and of credit by the Imperial Bank of India.
The Hilton-Young Commission, therefore, recommended that the dichotomy of functions and division of responsibility for control of currency and credit and the divergent policies in this respect must be ended by setting-up of a central bank – called the Reserve Bank of India – which would regulate the financial policy and develop banking facilities throughout the country. Hence, the Bank was established with this primary object in view.
Another objective of the Reserve Bank has been to remain free from political influence and be in successful operation for maintaining financial stability and credit. The fundamental object of the Reserve Bank of India is to discharge purely central banking functions in the Indian money market, i.e., to act as the note- issuing authority, bankers’ bank and banker to government, and to promote the growth of the economy within the framework of the general economic policy of the Government, consistent with the need of maintenance of price stability.
A significant object of the Reserve Bank of India has also been to assist the planned process of development of the Indian economy. Besides the traditional central banking functions, with the launching of the five-year plans in the country, the Reserve Bank of India has been moving ahead in performing a host of developmental and promotional functions, which are normally beyond the purview of a traditional Central Bank.
The above background becomes relevant in the context of certain unprecedented developments like retail inflation overshooting the given target of 4 (+)/(-) 2 percent being chased by RBI by more than one percent and RBI experimenting new alternatives for improving liquidity in the system and being transparent in seeking fiscal policy support while doing its best in policy areas where the central bank is in charge. To be factual, retail inflation was. 7.59 percent for January 2020, higher by 24 basis points from 7.35 percent reached in the previous month. MPC sees CPI inflation at 6.5 percent for January-March 2020 and 5.4-5 percent for April-September 2020. Chief Economic Advisor Krishnamurthy Subramanian agrees with RBI’s realistic assessment of inflation trajectory and is optimistic about headline inflation converging back to core inflation at 4.2-4.5 percent by July-August, 2020.
On February 6, 2020, after the usual three-days deliberations RBI’s Monetary Policy Committee (MPC), opted for retaining the base rates unchanged. For some time now, the central bank’s bank rate has not been having much influence on interest rates in the financial market. Media and the analysts have been camouflaging this trend by phrases like ‘market had already factored in the change’ or ‘it takes some time to percolate the impact to ground level’. In reality, this tool has lost the influence it had on the rate of ‘rent’ on resources till the beginning of last decade. This is not to underplay the significance of MPC’s professional assessment of the influence of developments in the economy on inflation-related issues. Definitely, the periodic assessments should serve as accelerator and brake in policy formulation.
Equally important is the statement setting out various developmental and regulatory policy measures for strengthening regulation and supervision; broadening and deepening of the financial markets; and enhancing customer education, protection and financial inclusion, issued by RBI simultaneously with the Monetary Policy Statement.
The introductory observation in the Monetary Policy Statement issued by RBI on February 6, 2020 reads:
“On the basis of an assessment of the current and evolving macroeconomic situation, the Monetary Policy Committee (MPC) at its meeting today (February 6, 2020) decided to:
• keep the policy repo rate under the liquidity adjustment facility (LAF) unchanged at 5.15 per cent.
Consequently, the reverse repo rate under the LAF remains unchanged at 4.90 per cent and the marginal standing facility (MSF) rate and the Bank Rate at 5.40 per cent.
• The MPC also decided to continue with the accommodative stance as long as it is necessary to revive growth, while ensuring that inflation remains within the target.
These decisions are in consonance with the objective of achieving the medium-term target for consumer price index (CPI) inflation of 4 per cent within a band of +/- 2 per cent, while supporting growth”.
In his address at St Stephen’s College, New Delhi on January 24, 2020, RBI Governor Shaktikanta Das dwelt in great detail the evolution of monetary policy in India (See Box for excerpts covering the period 2016 onwards). Concluding the speech, he said:
“Monetary policy frameworks in India has thus evolved in line with the developments in theory and country practices, the changing nature
of the economy and developments in financial markets. Within the broad objectives, however, the relative emphasis on inflation, growth and financial stability has varied across monetary policy regimes. Although global experience with financial stability as an added policy objective is still unsettled, the Reserve Bank has always been giving due importance to financial stability since the enactment of the Preamble to the RBI Act. The regulation and supervision of banks and non-bank financial intermediaries has rested with the Reserve Bank and has kept pace with the prescribed global norms over time. More recently, the focus of financial stability has not only confined to regulation and supervision but also extending the reach of formal financial system to the unbanked and unserved population.
Apart from financial inclusion, there is also a focus on promoting secured, seamless and real-time payments and settlements. This renewed focus on financial inclusion and secured payments and settlements are not only aimed at promoting the confidence of general public in the domestic financial system but also improving the credibility of monetary policy for price stability, inclusive growth and financial stability.
Joint effort by RBI and GOI to manage liquidity
While committing that efforts are on from government’s side to the covenants of the Fiscal & Budget management Act (FRBM) by containing fiscal deficit to agreed levels, responding to a debate in Parliament, Finance Minister Nirmala Sitharaman said that Centre is giving equal importance to all the four growth engines, namely, public investment, private investment, consumption and export. In support, she listed measures such as lowering corporate tax, removing dividend distribution tax, reducing Goods & Services Tax (GST) on electric vehicles, amending the Insolvency & Bankruptcy Code (IBC) forfaster disposal of cases and amalgamation of 10 public sector banks into four. Let us be optimistic about government’s will to mainstream and deploy nation’s domestic assets including equity investments in PSUs for promoting economic growth. One also expects productive use of all reserves including foreign exchange reserves to fetch reasonable return on investments, without depleting their real value.
RBI on its part, has become more active in deploying all weapons of monetary policy management in its armour more judiciously and on an ongoing basis. To support lending to auto, housing and MSME sectors, RBI has given exemption from the requirement to maintain 4 percent CRR (Cash Reserve Ratio) on deposits equivalent to the incremental loans disbursed by banks to these sectors. The exemption will be effective from the fortnight ended January 31, 2020. The first special lending window with this facility will be open till July 31, 2020. Under the Liquidity management Framework, RBI will also be using instruments like fixed and variable rate repo/reverse repo auctions, outright OMOs, forex swaps and other instruments from time to time.
*A slightly edited version was published in The Global Analyst, March 2020
M G Warrier
March 9, 2020
M G Warrier
March 9, 2020
Box : Excerpts from the address by RBI Governor Shaktikanta Das at St Stephen’s College, New Delhi on January 24, 2020 (Source: RBI Website)