Repo rate stays unchanged 

(MainsGS3:Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment.)

Context:

• The Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI), based on the macroeconomic situation and its outlook, decided unanimously on Thursday to keep the policy repo rate unchanged at 6.5%.
• Consequently, the standing deposit facility (SDF) rate will remain unchanged at 6.25% and the marginal standing facility (MSF) rate and the bank rate at 6.75%.

Monetary policy committee:

• Under the Reserve Bank of India, Act,1934 (RBI Act,1934) (as amended in 2016), RBI is entrusted with the responsibility of conducting monetary policy in India with the primary objective of maintaining price stability while keeping in mind the objective of growth.
• In May 2016, the RBI Act, 1934 was amended to provide a statutory basis for the implementation of the flexible inflation targeting framework.
• Section 45ZB of the RBI Act provides for the constitution of a six-member Monetary Policy Committee (MPC) to be constituted by the Central Government  to determine the policy rate required to achieve the inflation target.
• The MPC determines the policy repo rate required to achieve the inflation target.
• The MPC is required to meet at least four times in a year. The quorum for the meeting of the MPC is four members.
• Each member of the MPC has one vote, and in the event of an equality of votes, the Governor has a second or casting vote.
• Each Member of the Monetary Policy Committee writes a statement specifying the reasons for voting in favour of, or against the proposed resolution.

Inflation Targeting: 

• Under Section 45ZA, the Central Government, in consultation with the RBI, determines the inflation target in terms of the Consumer Price Index (CPI), once in five years.
• Accordingly, on August 5, 2016, the Central Government notified  4 per cent Consumer Price Index (CPI) inflation as the target for the period from August 5, 2016 to March 31, 2021 with the upper tolerance limit of 6 per cent and the lower tolerance limit of 2 per cent. 
• On March 31, 2021, the Central Government retained the inflation target and the tolerance band for the next 5-year period – April 1, 2021 to March 31, 2026.
• The RBI Act provides for the constitution of a six-member Monetary Policy Committee (MPC) to determine the policy rate required to achieve the inflation target.
• Failure to Maintain Inflation Target: The Central Government has notified the following as the factors that constitute failure to achieve the inflation target: (a) the average inflation is more than the upper tolerance level of the inflation target for any three consecutive quarters; or (b) the average inflation is less than the lower tolerance level for any three consecutive quarters.
• Where the Bank fails to meet the inflation target, it shall set out in a report to the Central Government: the reasons for failure to achieve the inflation target; remedial actions proposed to be taken by the Bank; and an estimate of the time-period within which the inflation target shall be achieved pursuant to timely implementation of proposed remedial actions.
• The operating framework of monetary policy aims at aligning the operating target – the weighted average call rate (WACR) – with the policy repo rate through proactive liquidity management to facilitate transmission of repo rate changes through the entire financial system, which, in turn, influences aggregate demand – a key determinant of inflation and growth.

Key terms:

• Repo Rate: The interest rate at which the Reserve Bank provides liquidity under the liquidity adjustment facility (LAF) to all LAF participants against the collateral of government and other approved securities.
• Standing Deposit Facility (SDF) Rate: The rate at which the Reserve Bank accepts uncollateralized deposits, on an overnight basis, from all LAF participants. 
• The SDF is also a financial stability tool in addition to its role in liquidity management. The SDF rate is placed at 25 basis points below the policy repo rate. 
• With introduction of SDF in April 2022, the SDF rate replaced the fixed reverse repo rate as the floor of the LAF corridor.
• Marginal Standing Facility (MSF) Rate: The penal rate at which banks can borrow, on an overnight basis, from the Reserve Bank by dipping into their Statutory Liquidity Ratio (SLR) portfolio up to a predefined limit (2 per cent). 
• This provides a safety valve against unanticipated liquidity shocks to the banking system. The MSF rate is placed at 25 basis points above the policy repo rate.
• Liquidity Adjustment Facility (LAF): The LAF refers to the Reserve Bank’s operations through which it injects/absorbs liquidity into/from the banking system. 
• It consists of overnight as well as term repo/reverse repos (fixed as well as variable rates), SDF and MSF. Apart from LAF, instruments of liquidity management include outright open market operations (OMOs), forex swaps and market stabilisation scheme (MSS).
• LAF Corridor: The LAF corridor has the marginal standing facility (MSF) rate as its upper bound (ceiling) and the standing deposit facility (SDF) rate as the lower bound (floor), with the policy repo rate in the middle of the corridor.

About the Reserve bank of India:

• The Reserve Bank of India (RBI) is the central bank of India that formulates, implements and monitors the monetary policy. 
• It was established on April 1, 1935 in accordance with the provisions of the Reserve Bank of India Act, 1934. 
• The role of RBI is to regulate money supply and maintain the price stability in the country. 
• The RBI also monitors the functioning of commercial banks and non-banking finance companies in India.

Concerns for economy:

• Developments in the global financial system, particularly the banking sector turmoil and the volatility and uncertainty they have triggered, have weighed heavily on policymakers’ decision to wait and watch. 
• India's banking and non-banking financial service sectors remain healthy and economic activity remains resilient.
• But rising credit costs pose risks to both consumption demand and private investment that was a key factor in the World Bank’s calculus earlier this week, when it cut India’s 2023-24 growth forecast to 6.3%. 

• With the global economy still facing headwinds including from unabated geopolitical tensions, which the World Bank warned could result in a recession were more shocks to occur, the RBI’s policymakers have judiciously chosen to subordinate their concerns over inflation, for now, so as to ensure the growth momentum is not undermined.

Challenges to overcome:

• Core inflation remains elevated across a range of goods and services and unyielding, the MPC faces a challenge in its mandate of achieving durable disinflation. 
• As the RBI’s latest Monetary Policy Report notes, upside risks to the inflation outlook emanate from factors including higher global crude and commodity prices and extreme weather conditions and deficient monsoon rains. 
• Already the sudden announcement of an output cut by OPEC+ producers had resulted in a jump in crude prices, which could well upset the RBI’s assumption of crude averaging $85 a barrel (for the Indian basket) this year. 
• Similarly, the outlook for food prices too is beset with uncertainty given the unseasonal rains in parts of the country combined with the likelihood of an El Niño, which could raise summer temperatures and depress monsoon rainfall. 
• Additionally, the RBI sees milk prices staying firm over the coming months amid fodder cost pressures.