The Reserve Bank of India (RBI) has released its Monetary Policy Report (MPR) in the wake of an unscheduled monetary policy meeting held in late March 2020. The meeting was convened to discuss uncertainties brought about by the nationwide lockdown due to the Covid-19 pandemic. A subsequent early policy review scheduled for April 2020 was subsequently cancelled.
Inflation Expectations
As per the report, the consumer price index (CPI)-based inflation, which remained elevated over the past few months, is expected to decrease throughout the financial year. It is tentatively projected that the CPI inflation will ease from 4.8% in the first quarter of 2020-21 to 4.4% in the second quarter, 2.7% in the third quarter and further down to 2.4% by the fourth quarter. These trends are attributed primarily to the high economic uncertainty currently prevailing.
Aggregate demand could weaken more than anticipated, further easing core inflation. However, supply bottlenecks may lead to higher pressures than expected. Under the assumptions of a normal monsoon season and no major exogenous or policy shocks, estimates suggest that inflation could oscillate between 3.6%-3.8%.
Key Changes in RBI Monetary Policy
Several key changes were made to the RBI’s monetary policy. The Repo Rate, which is the interest rate at which the central bank provides loans to commercial banks, was reduced by 75 basis points to 4.4%. The Cash Reserve Ratio, the percentage of total deposits that banks are required to hold as cash, was also lowered by 100 basis points to 3%. However, the RBI refrained from making any predictions regarding economic growth given the prevailing uncertainties connected to the Covid-19 pandemic.
Impact of Lower Oil Prices
The sharp drop in international crude oil prices could potentially improve the country’s terms of trade if it persists. However, the benefits from this are unlikely to counterbalance the impact of the shutdown and resultant loss of external demand.
Forecasted Effects on Exchange Rates
The uncertainty surrounding the global macroeconomic impact of Covid-19 has caused significant volatility in worldwide financial markets. This could place additional pressure on the Indian rupee. Should the rupee depreciate by 5% relative to the baseline, inflation could rise by approximately 20 basis points while GDP growth could increase by about 15 basis points through boosted net exports. On the other hand, should the situation normalise quickly, robust capital flows may be revived. In this scenario, an appreciation of the rupee by 5% could lead to a roughly 20 basis point moderation in inflation and around 15 basis point reduction in GDP growth relative to the baseline.
Monetary Policy Tools
RBI uses several tools as part of its monetary policy to control factors such as inflation, interest rates, money supply, and credit availability. This involves the use of methods such as the repo rate, reverse repo rate, bank rate, and Cash Reserve Ratio (CRR). These functions are overseen by the Monetary Policy Committee (MPC), which is constituted by the government. The reverse repo rate refers to the rate at which commercial banks deposit their money with the RBI. Bank rate is the rate charged by the RBI for lending funds to commercial banks.