The Reserve Bank of India (RBI) recently unveiled the Monetary Policy Report (MPR) for August 2021. This report continued the trend of maintaining the policy rate, which remained steady for the seventh consecutive time. Additionally, the RBI urged both the central and state governments to cut fuel taxes in an effort to mitigate inflationary pressures.
About the Monetary Policy Report and Its Establishment
The Monetary Policy Committee (MPC) of the RBI publishes the MPR. Enshrined under the RBI Act of 1934, the MPC acts as a statutory and institutional framework. Its primary objectives are to sustain price stability while also prioritizing economic growth. The committee determines the necessary policy interest rate (also known as the repo rate) to meet their inflation target of 4% ± 2%. The Governor of RBI simultaneously serves as the ex-officio Chairman of the MPC.
Key Points and Vital Decisions from the Report
The report highlighted several key decisions, such as maintaining various policy rates like the Repo Rate at 4%, Reverse Repo Rate at 3.35%, Marginal Standing Facility (MSF) at 4.25%, and Bank Rate at 4.25%.
The Real Gross Domestic Product (GDP) growth forecast for 2021-22 was left unchanged at 9.5%, while the projection for Consumer Price Index (CPI) inflation was revised slightly upwards to 5.7% from 5.1%.
To absorb surplus liquidity in the economy, the RBI announced the implementation of a Variable Rate Reverse Repo (VRRR) program due to its higher yield potential compared to fixed rate overnight reverse repos. The RBI has decided to gradually boost the VRRR to Rs 4 trillion and extend its liquidity support to banks lending to strained businesses up until December 31, 2021.
Steady Interest Rates and the Accommodative Stance
The elevated inflation level combined with a slow economic recovery has prompted the committee to maintain steady interest rates. It is expected that interest rates in the banking system will remain stable over the next few months. The MPC also decided to continue an accommodative stance as needed to stimulate and sustain growth. This stance also aims to alleviate the impact of Covid-19 on the economy while ensuring that inflation remains within their target range moving forward.
Optimism for Economic Recovery
The report highlighted some positive signs which point towards the possibility of a strong recovery. After the second wave of Covid-19, domestic economic activity began to pick up aided by an accelerating vaccination drive. Although investment demand remains weak, factors such as improved capacity utilization, increased steel consumption, a rise in capital goods imports, favorable monetary and financial conditions, and economic relief measures announced by the central government are anticipated to spur a long-awaited revival.
Concerns and Suggestions Presented in the Report
Despite the optimism, the report did express concerns about managing inflation becoming a significant challenge as fuel prices continue to rise. In response to this, the report suggested a “calibrated reduction” of indirect tax on fuel prices by both the centre and states to substantially alleviate cost pressures. It also emphasized the need for additional economic stimulus from the government to boost consumption, especially as the festive season approaches.
Understanding Key Terms in Monetary Policy
Repo rate refers to the rate at which the RBI lends money to commercial banks in the event of a funds shortfall. It involves the central bank purchasing the security. Conversely, the reverse repo rate is where the RBI borrows money from commercial banks within the country.
The bank rate is the rate charged by the RBI for lending funds to commercial banks. The Marginal Standing Facility (MSF) is an emergency borrowing window for scheduled banks from the RBI when interbank liquidity exhausts completely.
Inflation refers to a general increase in prices of everyday goods and services, which signals a decrease in the purchasing power of a country’s currency, potentially slowing down economic growth. Finally, the Consumer Price Index measures price changes from a retail buyer’s perspective and calculates the difference in the price of commodities and services such as food, medical care, education, electronics etc.
