Focused on inflation
GS Paper 3: Mobilization of resources, Growth, Development and Employment
Prelims exam: Monetary Policy Committee, Inflation
Mains exam: RBI efforts to contain inflation
The repo rate, the rate at which RBI lends money to commercial banks, has been hiked by one half of a percent. Considering the prevailing adverse global environment, resilience in domestic economic activity, uncomfortably high inflation level, the RBI has hiked the policy repo rate by 50 basis points, to 5.40%.
RBI Monetary Policy Highlights
• Repo rate: MPC takes unanimous decision to raise benchmark lending rate by 50 bps to 5.40 pc
• Policy stance: MPC decides to focus on withdrawal of accommodative policy stance to check inflation
• Inflation projection: For FY23 retained at 6.7 pc on assumption of normal monsoon and crude oil at USD 105/barrel
• Economic growth projection: RBI retains its projection at 7.2 per cent for current fiscal
• Bank credit growth: It has accelerated 14 pc as against 5.5 pc year ago
• FDI inflows: Improved to USD 13.6 bn in Q1 this fiscal, against USD 11.6 bn in corresponding period last year
• Rupee: RBI remains watchful of INR movement
• Liquidity: Surplus liquidity in the banking system has come down to Rs 3.8 lakh crore, from Rs 6.7 lakh crore in April-May
• Deposit rates: Rise in term deposit rates should increase liquidity for financial sector
What is leading the tightening of Policy
• From an external sector and exchange rate perspective as well, globalised inflationary surges are prompting policy tightening in advanced economies that is in turn roiling currency markets including appreciably weakening the rupee and adding imported inflation to the mix.
Imported inflation may be set off by foreign price increases, or by depreciation of a country’s exchange rate.
• Imported inflation is a general and sustainable price increase due to an increase in costs of imported products. This price increase concerns the price of raw materials and all imported products or services used by companies in a country. Imported inflation is also referred to as cost inflation.
• Imported inflation is also caused by a decline in the value of a country’s currency. The more the currency depreciates on the foreign exchange market the higher the price of imports. Effectively, more money is needed to buy goods and services outside the country.
• With imported inflation, production costs are higher for companies. These companies most often reflect this increase in the selling price of the goods and services sold. As a result, prices within the country rise. Imported inflation causes inflation.
• Let’s take the example of a French company that manufactures cotton clothing. To be able to manufacture these garments, the company must buy cotton from abroad, as France is not a cotton producer. It therefore imports cotton paying with Euros. If the value of the euro falls against the currency of the cotton exporting country, it must pay more euros to obtain supplies. To keep its margins, the company then decides to increase the selling price of its clothing in France. This is then imported inflation, as the selling prices of clothing sold in France have increased due to an increase in production costs.
• Russia’s invasion of Ukraine and the resultant impact on trade flows from the conflict zone have upended supply chains for several commodities and added to price pressures for a range of goods.
• The latest geopolitical tensions triggered in East Asia by U.S. House Speaker Nancy Pelosi’s visit to Taiwan in the face of Beijing’s dire warnings, and China’s decision to respond with aggressive military drills around one of the world’s busiest shipping lanes, could also impact global trade at a time when uncertainty and risk aversion are already high.
• ‘Successive shocks to the global economy’ had led multilateral institutions including the IMF to lower their global growth projections and ‘highlight the rising risks of recession’,
• Disquietingly, globalisation of inflation is coinciding with deglobalisation of trade.
Reason for successive hike in policy rate
The Monetary Policy Committee of the RBI came to this judgement since it felt the need to keep inflation and inflationary expectations under check. “Sustained high inflation could destabilise inflation expectations and harm growth in the medium term”.
Concern related to this
• Experts feel that Repo rate hike by RBI isn’t good news for small businesses and nation at large.
o Experts pointed out that lower interest rates allow easy borrowing, and businesses typically borrow to invest in new economic activities. Hence, the larger the cash supply, the more inflation.
• With interest rates at which banks borrow set to go up, personal loans, auto loans, and home loans will get expensive and new borrowers can expect EMIs to shoot up.
• Experts said that the RBI raising the repo rate by 50 bps is a good move. But with the wholesale price inflation of 15.18% and consumer inflation of 7.01%, small businesses in India are making losses and closing. While this may be good for big businesses, it is not good for the nation.
• Experts also questioned the ‘not dovish’ stand adopted by the MPC in the rate hike taking it to pre-pandemic levels.
o The withdrawal of an accommodative stance being maintained is contrary to market expectations of a dovish approach.
• Most felt that though the RBI MPC was in line with expectations, the hike was much over the 25-30 bps points expected.
• This is a trend that is expected to continue. While the housing sector has witnessed a recovery in demand across segments over the last year, the higher home loan rates could dent homebuyer sentiments.
Additional Measures By RBI to help the economy
The Governor announced a series of five additional measures, as given below.
1. Encouraging Standalone Primary Dealers to further Develop Financial Markets:
• Standalone Primary Dealers (SPDs) will now be able to offer all foreign exchange market-making facilities as currently permitted to Category-I Authorised Dealers, subject to prudential guidelines.
• This will provide customers with a wider set of market makers to manage their foreign currency risk. This will also increase the breadth of the forex market in India.
• SPDs will also be permitted to undertake transactions in the offshore Rupee Overnight Indexed Swap market with non-residents and other market makers.
• This measure will supplement a similar measure announced in February this year for the banks.
• These measures are expected to remove the segmentation between onshore and offshore OIS markets and improve price discovery.
• The measures are being taken, considering the role of SPDs in developing financial markets.
2. Managing Risks and Code of Conduct in Outsourcing of Financial Services
• There has been an increasing trend of outsourcing of financial services by regulated entities.
• Considering this, the RBI is going to issue a draft Master Direction on Managing Risks and Code of Conduct in Outsourcing of Financial Services for public comments.
• This is being done to strengthen the risk management framework and harmonise and consolidate the existing guidelines.
3. Bharat Bill Payment System to be open to NRIs as well
• The Bharat Bill Payment System (BBPS), an interoperable platform for standardised bill payments, will now be able to accept cross-border inward bill payments.
• This will thereby enable NRIs as well to use the system to pay their bills for utility, education and other such services, on behalf of their families in India. This will thus greatly benefit senior citizens.
4. Credit Information Companies to be brought under Reserve Bank Integrated Ombudsman Scheme (RB-IOS) 2021
• To make the RB-IOS more broad-based, Credit Information Companies (CICs) are being brought under the RB-IOS framework.
• With this, we get a cost-free alternative mechanism for redressal of grievances against Credit Information Companies.
• Further, these companies will now need to have their own internal Ombudsman (IO) framework.
• This will strengthen the internal grievance redress mechanism by CICs themselves.
5. MIBOR Benchmark Committee to be set up
• The RBI has decided to set up a committee to undertake an in-depth examination of the issues relating to development and use of interest rate derivatives, including the need for transitioning to an alternative benchmark for Mumbai Interbank Outright Rate, and suggest the way forward.
• The study is being done in view of recent international efforts to develop alternative benchmark rates.
Mumbai Interbank Offered Rate (MIBOR)
The Mumbai Interbank Offer Rate (MIBOR) is one iteration of India’s interbank rate, which is the rate of interest charged by a bank on a short-term loan to another bank.
• The Mumbai InterBank Overnight Rate, or MIBOR, is the overnight lending offered rate for Indian commercial banks.
• MIBOR is calculated based on input from a panel of 30 banks and primary dealers.
• MIBOR was first established in 1998, and modeled after the more famous London InterBank Overnight Rate (LIBOR).
The central bank, in coordination with the government, has ensured an orderly evolution of economic conditions during a very complex and challenging environment. The exit process now will also need the same adroit use of policy instruments.[/fusion_text][/fusion_builder_column][/fusion_builder_row][/fusion_builder_container]