Second bi-monthly Monetary Policy for fiscal 2018-19 - RBI


Ajit Kumar AJIT KUMARWISDOM IAS, New Delhi.

On the basis of an assessment of the current and evolving macroeconomic situation at its meeting, the Monetary Policy Committee (MPC) decided on June 6, 2018 to:
(i) hikes key lending rate (repo rate) under the LAF by 0.25 per cent to 6.25 per cent
(ii) repo rate rate hike is the first in four-and-half-years
(iii) reverse repo rate under the LAF adjusted at 6 per cent
(iii) the marginal standing facility (MSF) rate and the Bank Rate to 6.50 per cent. 
(iv) growth projection retained at 7.4 per cent for 2018-19
(v) projects retail inflation at 4.8–4.9 per cent for April-September, 4.7 per cent in H2
 
Neutral Stance
 
Post the rate hike, the MPC maintained its monetary policy stance at ‘neutral’, giving it the flexibility to move in either direction. A year ago, the Reserve Bank of India (RBI), had shifted its monetary policy stance from 'accommodative' to 'neutral'. A 'neutral' stance actually meant that RBI would move either way as against easing under the 'accommodative' stance. 
 
“The decision of the MPC is consistent with the neutral stance of monetary policy in consonance with the objective of achieving the medium-term target for consumer price index (CPI) inflation of 4 percent within a band of +/- 2 percent, while supporting growth,” the committee said in its statement.
A neutral stance leaves all options open. The MPC felt there was enough uncertainty to stick to neutral stance and yet respond to the risks to inflation target that have emerged in the recent months. A neutral stance gives an impression that there may not be a series of hikes.
 
To people, a neutral rate hike by the Reserve Bank of India means that bank loans will attract higher interest rates but fixed deposits will fetch better returns.
 
 
Why rate hike?
 
The MPC’s decision to hike policy rates comes against the backdrop of rising inflation, higher oil prices and a weaker currency.
 
The committee expects retail inflation at 4.8-4.9 percent in the first half of the year and at 4.7 percent in the second half of the year.
Retail inflation, which the MPC targets, stood at 4.58 percent in April.
Core inflation rose to a near four-year high of 6 percent. The MPC is targeting to maintain inflation in a band of 4 (+/- 2) percent. Since the last policy review, oil prices have risen by close to 12 percent and the rupee has depreciated nearly 3 percent.
A major upside risk to inflation has materialized due to higher oil prices, noted the MPC. It added that there has been a “significant rise” in household inflation expectations which could feed into wages and input costs.
Geo-political risks, financial market volatility, trade protectionism to impact domestic growth
Adherence to budgetary targets by the Centre and states will ease upside risks to the inflation outlook
 
However, Urjit Patel, RBI Governor said that the monetary policy is determined by our inflation targeting mandate and not by anything else. If there are international financial or crude oil or commodity price developments, then that is internalised in the inflation forecast and the consequential policy choice.-  said
 
Economic Growth
 
Meanwhile, growth has recovered along expected lines even though it remains supported by government spending. GDP growth rose to 7.7 percent in the fourth quarter of the financial year 2017-18 compared to 7 percent in the third quarter. The MPC sees GDP growth at 7.4 percent in FY19. Investment activity is recovering well and could receive a further boost from resolution of stressed assets, the MPC noted.
Investments recovering well; to get boost from swift resolution under IBC
 
                         Consequence of raising key rate
Within a day of RBI hiking the key lending rate, banks have started raising interest rates which will increase EMIs for auto, home and business loans.
Some big lenders including SBI, ICICI Bank and HDFC Bank had increased their Marginal Cost of Funds Based Lending Rates (MCLR) in anticipation of RBI raising repo rate, at which it lends money to banks.
 The cost of borrowing will go up. But banks will also hike deposit rates and it will be good for savers.
 
Sovereign Bonds Slipped
 
Indian sovereign bonds slipped and the rupee advanced after the policy announcement.
Indian bonds have already been battered by rising crude oil prices, a widening fiscal deficit and tighter cash conditions. Overseas funds are selling domestic debt at a record pace, while local state-run banks -- the biggest buyers of sovereign bonds -- are shunning the securities as they face mounting losses on their investments.
The central bank said it will also allow banks to spread losses incurred on their bond portfolios in the quarter ending June 30 equally over a period of four quarters.
Outflows from Indian bonds have also contributed to making the rupee one of the worst performers in Asia this year. The RBI joins its peers in emerging markets from Argentina to Indonesia, who have raised rates to counter capital outflows and weaker currencies that threaten to drive up inflation.
 
India imports about three quarters of its oil and rising prices not only threaten to stoke inflation, but also worsen the nation’s trade deficit, putting more pressure on the currency.
 
Consequently the Reserve Bank of India on June 7,  said it would buy 100 billion rupees ($1.5 billion) of securities with maturities ranging from 2020 to 2033 maturities on May 17.
 
Assessment of the Policy



Inflation risk may have forced the MPC’s hand, but growth continues to be overlooked


Amidst creeping inflation and a falling rupee, it would seem that the Monetary Policy Committee (MPC) was left with little option but to hike the repo rate by 25 basis points.
FIIs have been net sellers in recent months, exiting out of emerging markets to the safety of the dollar, with the Euro Zone decelerating and exhibiting signs of financial instability. Meanwhile, the US is normalising its monetary policy. If FII outflows have created pressure on the rupee, rising crude prices have added to it. A 12 per cent rise in oil prices since the last MPC meet in April to $76 a barrel has played a role in pushing the rupee down by 5 per cent since its January value, to ₹67 today.
 
Meanwhile, Moody’s ‘external vulnerability index’ — the ratio of short-term debt, maturing long-term debt and NRI deposits over a year to forex reserves — has been valued at 74 per cent in the case of India and 51 per cent in Indonesia’s case.
With exports growing by just 3 per cent, and imports at over 10 per cent, the MPC needed to take steps to restore confidence in India’s external account.
However, in future, the Reserve Bank could consider other ways to manage rupee demand, such as a forex swap window for oil companies.
It is clear that in an inflation-targeting arrangement, the MPC cannot be seen to be taking a lax view of rising prices. Hence, it has taken cognisance of the fact that projected inflation at 4.7-4.8 per cent for the remaining part of this year is above its medium-term target of 4 per cent.
However, it is intriguing that the MPC chooses not to invoke its mandated 2 per cent elbow room, at a time when greenshoots of growth are making their appearance.
Indeed, inflation numbers for the better part of this calendar year need to be discounted for their base effects.
It is hoped that the MPC, after raising rates this time, gives due consideration to growth in its subsequent assessments. With 10-year benchmark yields already ruling above 7.5 per cent, a further hardening of rates can make access to credit that much harder for MSMEs in particular.
The MPC should not lose sight of the fact that inflation that is cost-push in nature can co-exist with a situation of demand constraint.
However, the RBI’s move to ease credit terms for now to MSMEs not registered under GST is laudable. A balanced approach to growth, inflation and fiscal consolidation can see India through periods of turbulence.
 
Related Terms
 
Key lending rate - The key rate is the specific interest rate that determines bank lending rates and the cost of credit for borrowers.

Repo rate - Repo rate is the rate at which the central bank of a country (Reserve Bank of India in case of India) lends money to commercial banks in the event of any shortfall of funds. Repo rate is used by monetary authorities to control inflation.
 
Reverse repo rate - Reverse repo rate is the rate at which the central bank of a country (Reserve Bank of India in case of India) borrows money from commercial banks within the country. It is a monetary policy instrument which can be used to control the money supply in the country.
  Differences between Repo Rate and Reverse Repo Rate
(i) Repo rate is charged by RBI when commercial banks sell their securities. Whereas, reverse repo rate is the rate at which RBI borrows money from banks within the country.
(ii) While high repo rate drains excess liquidity from the market as the banks have to pay high interest to obtain loan from RBI, high reverse repo rate injects liquidity into the economic system by offering high profits to banks.
(iii) The repo rate is always higher than the reverse repo rate.
(iv) While repo rate is used to control inflation, reverse repo rate is used to control money supply in the market.
(v) The main objective of repo rate is to deal with deficiency of funds. Whereas, reverse repo rate deals with liquidity in the economy.
(vi) Repo Rate involves selling securities to RBI with a motive to repurchase it in the future at a fixed rate of interest but reverse repo rate is mere transferring of funds from one bank account to RBI account.
 
LAF - LAF is a facility extended by the Reserve Bank of India to the scheduled commercial banks (excluding RRBs) and primary dealers to avail of liquidity in case of requirement or park excess funds with the RBI in case of excess liquidity on an overnight basis against the collateral of Government securities including State Government securities. Basically LAF enables liquidity management on a day to day basis.
 
MSF rate - Marginal standing facility (MSF) is a window for banks to borrow from the Reserve Bank of India in an emergency situation when inter-bank liquidity dries up completely. 


Banks borrow from the central bank by pledging government securities at a rate higher than the repo rate under liquidity adjustment facility or LAF in short. The MSF rate is pegged 100 basis points or a percentage point above the repo rate. Under MSF, banks can borrow funds up to one percentage of their net demand and time liabilities (NDTL). 
 
Neutral Policy Stance - A neutral stance of RBI provides it the flexibility to move in either of the directions. But, prevailing risk of inflation may mean that the RBI won't cut down the interest rates.
 
Accommodative monetary policy Stance - Accommodative monetary policy occurs when a central bank (such as the Federal Reserve) attempts to expand the overall money supply to boost the economy when growth is slowing (as measured by GDP). 

MPC - The Monetary Policy Committee (MPC) is a committee of the Central Bank in India (Reserve Bank of India), headed by its Governor, which is entrusted with the task of fixing the benchmark policy interest rate (repo rate) to contain inflation within the specified target level. Altogether, the MPC has six members
 
consumer price index (CPI) - The Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care. It gives an idea of the cost of living.
Upside risk to inflation- increase beyond forecast levels
Household Inflation Expectations - Inflation expectations are an important marker for the conduct of monetary policy. Using a Bayesian structural that includes the inflation expectations of general public based on the Inflation Expectations Survey of Households (IESH), in a first of its kind of study using this dataset, we analyze the macroeconomic factors that determine inflation expectations in India with special focus on economic uncertainty.
Sovereign Bonds - A government bond or "'sovereign bond"' is a bond issued by a national government, generally with a promise to pay periodic interest payments and to repay the face value on the maturity date.
Benchmark rate- Minimum rate of return investors will accept for buying non-government (non-treasury) securities.






Saturday, 09th Jun 2018, 03:33:26 AM

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