From UPSC perspective, the following things are important :
Prelims level : LTRO
Mains level : Paper 3- Stance of MPC amid rising inflation
The article analyses the implications of the recently concluded MPC meeting and predicts the trends for the future.
Highlights of the MPC meeting
- In the October meeting of the monetary policy committee (MPC), repo rate were kept unchanged at 4%, with a continuation of an accommodative stance.
- It chose to ignore elevated levels of CPI inflation as transitory and maintaining focus on supporting growth.
- It appears that the MPC would maintain a status quo on rates through this fiscal year.
- The scope for further easing is anyways limited to 0.50%, as any more easing may affect household financial savings and endanger financial stability.
Ensuring the rate transmission
- With unchanged repo rates, the focus of the liquidity measures announced by the RBI is to further improve transmission of previous rate cuts across a spectrum of market rates and other instruments.
- The RBI Governor assured market participants that the large supply of government bonds in the second half along with a likely pick-up in credit demand, would be accommodated through open market purchases of government bonds.
Reducing the cost of borrowing
- The RBI may have to buy bonds worth ₹1,000 to 1,500 billion in these operations over 2HFY21 keeping pressure on yields [which affects interest rates].
- In a related move, to reduce the cost of borrowings for state governments, the RBI for the first time will buy state government bonds, as a special case for this year.
- The extension of enhanced Held to Maturity (HTM) limit of banks on their government bonds portfolio to March 2022.
- A new on-tap targeted LTRO window was announced, for banks to borrow up to ₹1,000 billion from the RBI at a floating rate linked to the repo rate, and invest in corporate paper issued by specific sectors and to provide loans to them.
- In effect, the aim of the central bank is to ensure that lower policy rates determined by the macro-economic fundamentals, are reflected in lower cost of borrowings for the Centre, states and corporates.
- Inflation outlook for this fiscal and projections for next year indicate that CPI inflation would ease, from an average of 6.8% in Q2 to 4.5% in Q4 and 4.1% by Q4FY22.
- Headline inflation is expected to fall, as supply conditions normalize with progressive unlocking and another year of bumper farm output helps pull down food inflation.
- Higher fuel taxes and import duties are expected to provide an upward push though.
- Effective supply management will therefore be crucial in controlling food inflation and ensuring that it does not turn persistent and feeds into non-food inflation.
- The role of monetary policy in the is limited and the RBI focus will remain on improving transmission of policy signals through banking, bond and credit market channels.
- Long-Term Repo Operation (LTRO) was introduced by the Reserve Bank in February, 2020.
- Through this policy, the central bank would provide liquidity support to commercial banks for a period of 1 to 3 years at the current repo rate, and would accept government securities as collateral in return.
- This is in contrast to the other measures it was providing such as Liquidity Adjustment Facility (LAF) and Marginal Standing Facility (MSF) which provide cash to banks for a period of 1 to 28 days only.