The Reserve Bank of India (RBI) is a critical pillar in the Indian financial structure. Its main instrument of operation is the Monetary Policy Committee (MPC), which oversees monetary policy implementation, sets benchmark interest rates, and is responsible for managing the money supply and controlling inflation.
The Dynamics of Monetary Policy
Monetary policy refers to the guidelines set by a central bank to control the money supply in an economy. It allows for the monitoring and regulation of interest rates and total money supply in circulation with the primary goal of maintaining economic stability.
In India, the RBI uses monetary policy as a tool to control inflation, maintaining it within an upper limit of 6%. By adopting what is known as an accommodative stance, the RBI shows a willingness to expand the money supply and cut interest rates to keep the economy on the right trajectory.
Instruments of Monetary Policy
The RBI makes use of several instruments of monetary policy. Some of these include:
1. Repo Rate: This is the rate at which RBI provides overnight liquidity to banks.
2. Reverse Repo Rate: This refers to the rate at which RBI absorbs liquidity from banks.
3. Liquidity Adjustment Facility (LAF): This includes term repurchase operations to help develop the interbank money market, which consequently determines the pricing of loans and deposits.
More so, there are other tools such as the Marginal Standing Facility (MSF), Bank rate, Cash Reserve Ratio (CRR), Statutory Liquidity Ratio (SLR), Open Market Operations (OMOs), and the Market Stabilization Scheme (MSS).
Deciphering the Monetary Policy Committee (MPC)
The Monetary Policy Committee (MPC), established under Section 45ZB of the amended (2016) RBI Act, 1934, is a six-member committee. The MPC’s core role is to determine the policy rate necessary to achieve the inflation target. Section 45ZB also outlines the composition of the MPC, which includes the RBI Governor as the ex-officio chairperson.
Role of Monetary Policy Framework
Amendments made to the RBI Act in May 2016 provided a legislative mandate to the RBI to operate under a monetary policy framework. This framework places priority on setting the policy (repo) rate based on an assessment of the current and evolving macroeconomic situation. Consequently, it modulates liquidity conditions and influences aggregate demand, making it a key determinant of inflation and growth.
Various Policy Stances of RBI
The RBI adopts several policy stances, which include:
1. Accommodative Stance: In this stance, the central bank is prepared to expand the money supply to stimulate economic growth.
2. Neutral Stance: In this instance, the central bank could either cut or increase the rate depending on the scenario.
3. Hawkish Stance: Under this policy, curbing inflation is the top priority.
Another orientation is the calibrated tightening policy, wherein the overall policy leans towards a rate hike but not necessarily at every policy meeting. Various factors influence these decisions, and they are executed with utmost deliberation.
