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1st Bimonthly Monetary Policy review – April 2019

1st Bimonthly Monetary Policy review – April 2019

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  • GS 3 || Economy || Banking & Financial Sector || RBI

Why in news?

  • In its first meeting in FY’20, the Monetary Policy Committee (MPC) of the Reserve Bank of India cut the key lending rate — repo rate — by 25 basis points from 6.25% to 6% .
  • Of the six members on the committee, The panel voted 4-2 in favour of the rate cut.

Monetary Policy Committee

  • The RBI has a government-constituted Monetary Policy Committee (MPC) which is tasked with framing monetary policy using tools like the repo rate, reverse repo rate, bank rate, cash reserve ratio (CRR).
  • Among them, the repo rate, also known popularly as the policy rate, is the most powerful one. The repo rate is the interest rate at which the RBI provides loans to banks.

Constitution of the MPC

  • The Central Government constitutes the MPC through a notification in the Official Gazette.
  • Altogether, the MPC will have six members
    • the RBI Governor (Chairperson),
    • the RBI Deputy Governor in charge of monetary policy,
    • one official nominated by the RBI Board and
    • the remaining three members would represent the Government of India.
  • These Government of India nominees are appointed by the Central Government based on the recommendations of a search cum selection committee consisting of –
    • the cabinet secretary (Chairperson),
    • the RBI Governor,
    • the secretary of the Department of Economic Affairs, Ministry of Finance, and
    • three experts in the field of economics or banking as nominated by the central government.
  • The three central government nominees of the MPC appointed by the search cum selection committee will hold office for a period of four years and will not be eligible for re-appointment.
  • The proceedings of MPC are confidential and the quorum for a meeting shall be four Members, at least one of whom shall be the Governor and in his absence, the Deputy Governor who is the Member of the MPC.
  • The MPC takes decisions based on majority vote (by those who are present and voting).
    • In case of a tie, the RBI governor will have the second or casting vote.
    • The decision of the Committee would be binding on the RBI.

As per the Act, RBI has to organise at least four meetings of the MPC in a year. (More meetings can be held if the RBI Governor is of that opinion).

Highlights

  • Reverse repo rate has been adjusted to 5.75 per cent.
  • Stance: The committee kept the monetary policy stance at ‘neutral’. In the last review in February, the MPC shifted its stance to ‘neutral’ from ‘calibrated tightening’.

  • GDP growth projections: Besides, the RBI has also revised its GDP projection downwards for FY’20.
    • The RBI has slashed the GDP growth forecast to 7.2% for 2019-20 from 7.4% projected in the February policy amid some signs of domestic investment activity weakening as reflected in a slowdown in production and imports of capital goods.
    • GDP growth for 2019-20 is projected at 7.2 per cent — in the range of 6.8-7.1 per cent in the first half of 2019-20 and 7.3-7.4 per cent in the second half — with risks evenly balanced.
  • Inflation: The RBI has revised the path of CPI inflation downwards to 2.4 per cent in Q4 of 2018-19, 2.9-3.0 per cent in the first half of 2019-20 and 3.5-3.8 per cent in H2 of 2019-20, with risks broadly balanced.

Impact

  • Increase in money supply: The repo rate is an instrument used by the Reserve Bank of India to control inflation.
    • It is the rate at which the central bank (Reserve Bank of India) lends money to commercial banks in the event of any shortfall of funds.
    • The expectation of a rate cut is based on a lower inflation rate as well as slower growth in the economy.
  • Less interest on loans: When RBI cuts repo rate, banks need to pay less interest on their borrowings from RBI.
    • Thus, banks also charge less on their loans and it thereby raises money circulation, which leads to price rise and increase economic activity.
  • Depositors receive low interest: For a depositor, the new deposits earn a lower rate and it means lower returns.
    • However, as a borrower, a downward revision of interest rate would bring down interest outgo in the near future.

Additional info

Monetary Policy Stance

  • RBI, in addition to regulating policy rates, indicates the market condition to ensure stability. This is done through what some call, in banking parlance, ‘monetary policy stance of the RBI’. The below mentioned terms depict the stance RBI adopts from time to time keeping in mind the current condition.
    • Calibrated tightening: means that in the current rate cycle, a cut in the policy repo rate is off the table, and MPC is not obliged to increase the rate at every policy meeting.
    • Neutral: As the name suggest, RBI remains watchful but, neutral. A neutral policy will mean that depending upon the situation; RBI can increase or decrease interest rates.
    • Accommodative: It shows that RBI is ‘accommodative’ in taking policy rate decisions. It believes that economy needs to grow and hence, it will decrease the policy rate further in future.
  • These stances are meant to keep the 4% inflation target set by the government within permissible limits. Also, these stances help in reducing uncertainties and volatility in the market which big businesses don’t like at all.

Mains question

  • What does the RBI’s rate cut indicate? Why did RBI revise the GDP growth downwards?