Monetary Policy Committee (MPC) is a 6 member committee formed after the amendment in the RBI Act, 1934 through the Finance Act, 2016. Price stability, economic growth, equity, social justice, promoting and nurturing the new monetary and financial institutions are the basic objectives of Monetary Policy.
The composition of the MPC as on April 2019 is as follows:
Governor of the Reserve Bank of India – Chairperson, ex officio; (Shri Shaktikanta Das)
Deputy Governor of the Reserve Bank of India, in charge of Monetary Policy –BP Kanungo (Member, ex officio)
One officer of the Reserve Bank of India to be nominated by the Central Board – Member, ex officio; (Dr. Michael Debabrata Patra)
Dr. Ravindra H. Dholakia, Professor, Indian Institute of Management, Ahmedabad – Member
Professor Pami Dua, Director, Delhi School of Economics – Member
Shri Chetan Ghate, Professor, Indian Statistical Institute (ISI) – Member
The instrument of monetary policy are of two types:
Quantitative Instruments: General or indirect (Cash Reserve Ratio, Statutory Liquidity Ratio, Open Market Operations, Bank Rate, Repo Rate, Reverse Repo Rate, Marginal standing facility and Liquidity Adjustment Facility (LAF))
Qualitative Instruments: Selective or direct (change in the margin money, direct action, moral suasion)
These instruments maintain the flow of money supply in the economy so that the rate of inflation can be stabilised for ensuring the growth of the Economy.
Monetary Policy meeting
The Monetary Policy is going to meet six times in the current financial year FY 19-20. According to the schedule provided by the RBI, the second meeting of the MPC in the next fiscal will be held on June 3, 4 and 6; third meeting (August 5-7); fourth meeting (October 1, 3 and 4); fifth meeting (December 3-5) and sixth meeting (February 4-6, 2020).
The Reserve Bank of India lowered its benchmark repo rate by 25 bps to 5.15 percent during its October meeting, as widely expected. This was the fifth straight rate cut so far this year, in an attempt to boost slowing economic growth.
The trend of repo rate in the past 18 months has been shown in the chart given below:
The RBI is committed to improving monetary policy transmission, and meet the day-to-day, as well as durable needs of economy
The liquidity conditions went into surplus mode from June 2019, after remaining largely in deficit since September 2018.The daily average liquidity deficit under the LAF stood at Rs. ~727 billion in April 2019 and ~Rs. 366 billion in May 2019.
Durable liquidity infusion has improved through OMO purchase of government securities by RBI of Rs 250 billion and Rs. 275 billion, respectively, in May 2019 and June 2019.
Liquidity Infusion (-)/ absorption (+) (Net overnight & term Repos/Reverse Repos; MSF; MSS)
In June 2019, the RBI had announced the formation of an internal committee to review the Liquidity Management Framework. The recommendations of this committee, in addition to the trend in credit demand, deposit growth, Government spending and magnitude of FII inflows, will impact the systemic liquidity dynamics going forward.
Key highlights and future outlook:
In the third bi-monthly resolution of August 2019, CPI inflation was projected at 3.1 percent for Q2:2019-20, 3.5-3.7 per cent for H2:2019-20 and 3.6 per cent for Q1: 2020-21 with risks evenly balanced. The actual inflation outcomes for Q2 so far (July-August) at 3.2 percent have been broadly in line with these projections.
The outlook for food inflation has improved considerably since the August bi-monthly policy. Kharif production is estimated at close to last year’s level, auguring well for the overall food supply situation. Vegetable prices may remain elevated in the immediate months but are likely to moderate as winter supplies enter the market. Prices of pulses are expected to remain contained by adequate buffer stocks.
Forward looking surveys conducted by the Reserve Bank point to weak demand conditions persisting, with indications of softening of output prices in Q3:2019-20.
Crude oil prices may remain volatile in the near-term; while global demand is slowing down, the persisting geo-political uncertainties pose some upside risks to the inflation outlook.
Three-month and one-year ahead inflation expectations of households polled by the Reserve Bank have risen in the current round reflecting near-term price pressures.
Financial markets remain volatile with currencies of several emerging market economies trading with a depreciating bias in the recent period.
Overall CPI inflation projection is revised slightly upwards to 3.4 per cent for Q2:2019-20, while projections are retained at 3.5-3.7 per cent for H2:2019-20 and 3.6 per cent for Q1:2020-21, with risks evenly balanced.
Real GDP growth for 2019-20 in the August policy was projected at 6.9 per cent – in the range of 5.8-6.6 per cent for H1:2019-20 and 7.3-7.5 per cent for H2 – with risks somewhat tilted to the downside; GDP growth for Q1:2020-21 was projected at 7.4 per cent. GDP growth for Q1:2019-20 was significantly lower than projected.
Various high frequency indicators suggest that domestic demand conditions have remained weak.
The business expectations index of the Reserve Bank’s industrial outlook survey shows muted expansion in demand conditions in Q3.
Export prospects have been impacted by slowing global growth and continuing trade tensions.
On the positive side, however, the impact of monetary policy easing since February 2019 is gradually expected to feed into the real economy and boost demand. Several measures announced by the Government over the last two months are expected to revive sentiment and spur domestic demand, especially private consumption.
Real GDP growth for 2019-20 is revised downwards from 6.9 per cent in the August policy to
1.1 per cent – 5.3 per cent in Q2:2019-20 and in the range of 6.6-7.2 per cent for H2:2019-20 – with risks evenly balanced; GDP growth for Q1:2020-21 is also revised downwards to 7.2 per cent.
Challenges before the MPC
The RBI act mandates MPC to ensure the inflation is within the stipulated targets (current target: between 2% to 6%). MPC is facing diverse challenges in this regard. The challenges faced by MPC are:
Crude Inflation: The increasing crude oil price is having a spillover on inflation. India is a net importer of crude oil with inelastic demand. The crude inflation is bound to have a significant impact on the functioning of MPC which has been entrusted with maintaining inflation, a key component of macroeconomic stability.
Rupee volatility: The rupee has depreciated by 20 percent since May 2014. The depreciation of the Rupee is more than 12 percent since the beginning of 2018. The increasing possibility of a Fed rate hike, rising wages, and positive employment figures will put further thrust upward pressure on the rupee. Estimates suggest that 10 percent depreciation in the rupee could add up to 50 basis points to inflation.
Policy options to deal with the challenges
Open market operations: RBI can intervene in the foreign exchange market through open market operations to manage volatility. With trade deficit increasing inflation showing upward pressure, RBI can intervene to arrest the depreciation of the rupee.
Foreign exchange swap window: RBI can revisit the foreign exchange swap window offered by RBI for oil companies in 2013. Under the swap provisions oil marketing companies can swap rupee for dollars and after a definite time period return the dollars back to RBI.
Non-resident Indians: RBI can raise dollars by borrowing from non-resident Indians. This will increase the inflow of dollars and can reduce the rupee volatility.
Policy rate: RBI along with MPC can increase the policy rate to address the volatility and arrest inflation in the market. With looming domestic and overseas uncertainties there is a need for a concentrated approach by RBI to ensure the inflation targets are met without having the spillover effect on growth rates.