The Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) kept policy rates unchanged and introduced a Standing Deposit Facility (SDF), which will be a floor rate. He said a nuanced and agile approach will be taken to liquidity management. Mint looks at:

How is the macro-environment?

Elevated geopolitical tensions, risks of further disruptions to strained global supply chains and rising input costs due to high commodity and crude oil prices have posed a challenge to countries around the world, and India is no exception. A US Federal Reserve official said its interest rate policy was “below the curve” and was ready to raise rates faster to curb inflation. Foreign investors withdrew. 1.44 trillion from Indian markets in FY22. Domestic consumer demand is slowly showing signs of recovery and capacity utilization improved to 72.4%. However, higher domestic inflationary conditions may act as a drag.

What was the inflation trend?

Retail price inflation in India has been on the rise since September 2021, reaching 6.07% in February 2022, from 6.01% in January. This is the second month in a row that inflation has crossed the RBI 6% threshold. The inflation targeting framework requires RBI to keep retail price inflation at 4% plus or minus 2%. Wholesale inflation was 13.11% in February against 12.96% in January. RBI’s challenge is to balance inflation in the economy while supporting government borrowing; that is, controlling sovereign borrowing costs and fostering economic growth.

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The challenge of inflation

What were the main decisions of the MPC?

The MPC left the repo rate unchanged at 4%, introduced the SDF, revised its annual inflation forecast for FY23 to 5.75% from 4.5%, and reduced the estimate gross domestic product (GDP) growth for FY23 to 7.2% (assuming the price of crude oil is $100). a barrel). But he mentioned that the position would be less accommodating and that there would be a calibrated withdrawal of liquidity.

What is the SDF provided to banks?

At the last meeting, banks were offered a facility to store excess liquidity through an auction system, which was in addition to the reverse repo facility. The idea is to suck excess liquidity out of the system through the variable repo rate. Now, RBI has regularized the same under the SDF window, which offers an interest rate of 3.75% for parked funds without any collateral. The SDF window will help banks earn a minimum return when they have excess funds. The SDF rate of 3.75% would be the floor rate.

How will phasing out RBI help?

Central banks are expected to respond appropriately to prevailing economic situations by strategizing through monetary tools. Studies have shown that using these tools, central banks manage to largely contain demand-driven inflation. Cost inflation can only be controlled through effective supply management, which can be achieved through appropriate fiscal measures. Thus, venturing into a restrictive policy approach could lead to stagflation.

Jagadish Shettigar and Pooja Misra are faculty members of BIMTECH.

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