The Reserve Bank of India Governor, Mr. Shaktikanta Das, the head of the Monetary Policy Committee (MPC) along with its other members, bi-monthly publishes the Monetary Policy setting the benchmark interest rates in the country. The role of the MPC is to keep inflation and other interest rates in check. It is based on these rates that the banks in the country decide the lending and borrowing rates. The rates set by the MPC form a base rate for the various interest rates in the economy.
On 8th April 2022, the MPC policy kept its stance accommodative but mentioned its focus shifting towards withdrawal of accommodation in the coming years. The Monetary policy has an objective of keeping the inflation within a range of 2%-6%. Since the inflation is way above this range, the MPC shifted its focus from working towards developing a growth economy to lower inflation levels to sustain the economy. Thus, the MPC made inflation control its primary focus and growth the secondary one.
Major Reasons for the Change
The Ukraine – Russia war has been creating fresh challenges in the world since the day it started. As the war draws on and sanctions and retaliatory actions intensify. It has further led to shortages, volatility in commodity and financial markets, supply dislocations and persistent inflationary pressures. This has even led to global economic recovery to lose its pace.
Instead of a usual bi-monthly meeting, the MPC held an off-cycle meeting on 2nd and 4th May 2022 to reassess the evolving inflation-growth dynamics and the impact of the developments after the MPC meeting of April 6-8, 2022. Based on the assessment, the MPC voted unanimously to increase the policy repo rate for the first time since March 2020 by 40 basis points to 4.40%. The standing deposit facility (SDF) rate has been increased from 3.75% to 4.15% and the marginal standing facility (MSF) rate and the Bank Rate to 4.65% from 4.25%. It has also been decided to increase the cash reserve ratio (CRR) by 50 basis points to 4.5%, effective from May 21, 2022.
The monetary policy by remaining on an accommodative stance, continues to support growth and mitigate the adverse effects of the geopolitical crisis. As a result, the Indian economy has managed to weather the shock so far. Looking at the continuously increasing inflationary pressure, the MPC on 4th May 2022 announced withdrawal of accommodation to ensure inflation remains aligned to the target. The accommodative stance of the monetary policy means that it will undertake measure to infuse liquidity in the market and therefore lower the interest rates.
Whereas withdrawal of accommodation means that the monetary policy will cautiously take actions that will suck out the liquidity from the market and lead to interest rates rising in the economy. These are extremely cautious steps by the MPC keeping in mind that it doesn’t have adverse impact on the economy which may hamper its growth.
Along with inflation being at its peak levels and exports reduction by key producers the effect falls directly on various necessary products. This creates product shortage and thus an increase in prices. Also, the jump in fertiliser prices and other input costs has a direct impact on food prices in India. Further, the normalisation of monetary policy in major economies is now under assumption to gain pace significantly both in terms of rate increases and reducing of quantitative easing as well as increase of quantitative tightening.
These situations have significant implications on emerging economies like India. The economy has just been recovering from Covid-19 crisis impact. On the other hand it is facing inflationary crisis.
Thus, the MPC assumes that an appropriate and timely response to ensure that the second-round effects of supply side shocks on the economy is important. Also long-term inflation expectations are kept firmly down and therefore the vote is unanimously on the withdrawal of the accommodative stance. This would also help to preserve financial stability amidst increasing volatility in financial markets.
Statements At the Announcement Time
RBI further said that there has been a spike in inflation since March and the same might continue for the coming months till the geopolitical tensions in the world leading to shortage and high commodity prices stops. To ensure that the impact of these changes is minimal in the domestic economy, the MPC says that it will regularly undertake policy changes to preserve macroeconomic and financial stability while enhancing the economy’s resilience. The situation is dynamic and fast changing and thus anticipable actions must be initiated.
Though there has been continuous decrease in FDI in the stock market but the support by domestic investments is reducing this effect and showing revival in the investment cycle also. In this high-voltage global environment, the domestic economy has been progressing towards reviving itself and being strong to withhold the external shocks. The MPC will ensure to take necessary steps to curb inflation while keeping its support on growth.