Monetary Policy Review - October 2021

How is it going to affect your pocket?

Monetary policy is a set of tools that a country’s central bank has available to promote sustainable economic growth by controlling the overall supply of money within the economy. In India, Reserve Bank of India Act, 1934, entrusted the Reserve Bank of India (RBI) as the central bank and provided for the constitution of a six-member Monetary Policy Committee (MPC) by the Government of India.

Monetary policy can be restrictive, accommodative or neutral depending on the economic climate the country is in. For example, when there is less money in the economy and growth is sluggish, the monetary policy may implement measures to improve the supply and stimulate growth. Conversely, more money in the economy is likely to incur a restrictive approach by extracting excess money out of the system.

Instruments of Monetary Policy

There are direct and indirect tools that are used to implement monetary policy by the Reserve Bank of India and these include:

Key takeaways from the October 21 policy review

Based on the recent economic conditions, the RBI MPC suggested domestic considerations may outweigh the global. In a unanimous decision, it maintained an accommodative approach by leaving the repo rate unchanged at 4.0%, the reverse repo rate at 3.35%, and the MSF rate at 4.25%.

Here’s how it might impact borrowers and investors:

Economy: The GDP forecast is found to remain unchanged at 9.5% YoY for FY22 and the MPC is circumspect of India’s growth outlook owing to output still being below pre-COVID level. The MPC acknowledged the ongoing normalisation in high frequency indicators, but cautionary measures because of COVID uncertainties and supply disruptions, sub-par capacity utilisation^[1], along with subdued credit growth indicate a sustained challenging growth environment.

Inflation: FY22 Consumer Price Index (CPI) inflation projection was found to have lowered to 5.3% from 5.7% before. The catch-up in kharif sowing and record production were expected to have a salutary effect on food inflation, alongside administrative measures by the government (import tax cuts). However, the upturn in commodity prices, including oil, metals, elevated inputs prices - shortage of raw materials, high logistics costs – were viewed as risks and keeping core pressures up.

Liquidity: There is need for more liquidity support, but the RBI suggests that this process be “gradual, calibrated, and non-disruptive” in order to be in sync with the pace of economic developments. In this regard, the RBI will be scaling the variable reverse repo rate^[2] gradually from INR 4trn to INR 6trn by early December. In what is being perceived as a tapering signal, the RBI is suspending the G-Sec Acquisition Program (G-SAP)^[3] auctions.

Additional measures: The MPC outlined other steps including encouraging retail digital payment solutions in the offline mode since the success of the pilot runs. It is extending the interim enhancements limits on the Ways and Means Advances (WMA)^[4] provision for states and union territories up to March 2022, to help them tide over the pandemic-induced difficulties. Lastly, the RBI is also extending the three-year long-term Special Long-Term Repo Operations (SLTRO) for Small Finance Banks (SFBs) till December 31, 2021.

Overall, the RBI’s bi-monthly policy’s accommodative stance indicates its aim to keep optimism among market participants. Learn more about monetary policy updates and how it helps manage the impact of inflation in India and on your pocket. Download the report.

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^[1] It is the measure, in percentage, of a company’s potential output that is being realized, as stated by Corporate Finance Institute.

^[2] To remove excess liquidity from the market and ensure short term rates are near the reverse repo rate, the RBI decided to conduct the variable reverse repo rate auctions under the revised liquidity management framework, as explained in ‘Variable rate reverse repo auctions indicate monetary tightening, say analysts’ published in The Hindu.

^[3] A structure OMO of a larger scale and size that aims to maintain the yield curve of bonds to regulate the availability of liquidity in the economy, as explained by the Reserve Bank of India.

^[4] Defined by the RBI as ‘advances repayable in each case not later than three months from the date of the making of the advance’. The Reserve Bank of India has been extending WMA to State Governments since 1937.