RBI’S POLICY STANCE AS ‘WITHDRAWAL OF ACCOMMODATION’

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Context: The Reserve Bank of India (RBI) has maintained its status quo on key interest rates for the fourth consecutive time in its recent Monetary Policy Committee (MPC) meeting. This decision is driven by several economic factors and challenges that India faces.

Details

• The RBI has maintained a withdrawal of accommodation stance since June 2023, when it raised the repo rate by 25 basis points (bps) to 6.5%. This was the first rate hike since February 2020, when the repo rate was at 5.15%. The RBI cited rising inflationary pressures, supply-side shocks and global uncertainties as the reasons for tightening monetary policy.
  • Since then, the RBI has kept the repo rate unchanged at 6.5% for four consecutive meetings, including the latest one on October 6, 2023.
• The MPC voted unanimously to keep the repo rate unchanged and five out of six members voted to retain the withdrawal of accommodation stance. The RBI said that it will continue to monitor inflation closely and will take further measures as necessary to anchor inflation expectations.

Implications for the economy and financial markets

• It signals that the RBI is concerned about inflation and is willing to sacrifice some growth for price stability. The RBI has revised its inflation projection for 2023-24 from 5.1% in August to 5.4% in October, citing higher commodity prices, supply chain disruptions, demand pressures and fiscal slippages as upside risks. The RBI's inflation target is 4% with a tolerance band of +/- 2%.
• It indicates that the RBI is preparing for a gradual normalization of monetary policy as the economy recovers from the pandemic shock. The RBI expects GDP growth to rebound to 9.5% in 2023-24 from a contraction of 7.3% in 2020-21, supported by robust consumption, investment, exports and government spending. The RBI also expects growth momentum to sustain in 2024-25 at around 8%.
• It affects the borrowing costs and bond yields in the market. The withdrawal of the accommodation stance implies that there is less scope for further rate cuts by the RBI and that there could be more rate hikes in the future if inflation persists. This increases the expectations of higher interest rates and reduces the demand for bonds, leading to higher bond yields. Higher bond yields also increase the cost of borrowing for the government, corporates and households.

Steps to cope with the withdrawal of accommodation

• The government has announced various fiscal measures to support the economy during and after the pandemic, such as stimulus packages, tax relief, expenditure reprioritization, asset monetization and privatization plans. The government has also revised its fiscal deficit target for 2023-24 from 6.8% of GDP in February to 6.4% of GDP in July, indicating some fiscal consolidation.
• The government and the RBI have coordinated their actions to ensure smooth market functioning and debt management. The government has adopted a flexible and transparent borrowing calendar and has accepted the RBI's recommendations on the size, timing and maturity of bond issuances. The RBI has also conducted special OMOs, operation twists and G-SAPs (government securities acquisition programmes) to support the bond market and ease the yield curve.
• The government and the RBI have also taken steps to address the structural issues and supply-side bottlenecks that contribute to inflation. The government has announced various reforms in the agriculture, labour, infrastructure and financial sectors to improve productivity, efficiency and competitiveness. The RBI has also enhanced its communication and guidance on inflation expectations and policy outlook.

Challenges

• The persistence of inflation above the RBI's target range for several months could erode the credibility and effectiveness of monetary policy. It could also reduce the real income and purchasing power of consumers, especially the poor and vulnerable sections. It could also affect the external balance and exchange rate stability.
• The uncertainty and volatility in the global environment could affect India's growth prospects and financial stability. The emergence of new variants of COVID-19, the divergence in monetary policies among major economies, the geopolitical tensions, and the fluctuations in commodity prices and capital flows are some of the factors that could create shocks and spillovers for India.
• The trade-off between growth and inflation could become more challenging as the economy recovers from the pandemic. The RBI may face a dilemma between supporting growth with lower interest rates or containing inflation with higher interest rates. The RBI may also have to balance between providing adequate liquidity to the system or draining excess liquidity from the system.

Way forward

• The RBI should maintain its data-driven and forward-looking approach to monetary policy while being responsive to changing conditions and expectations. The RBI should also communicate clearly and transparently its policy rationale, objectives and actions to enhance its credibility and effectiveness.
• The government should adhere to its fiscal consolidation path while prioritizing growth-enhancing and quality spending. The government should also accelerate its reform agenda, especially in the areas of agriculture, labour, infrastructure and financial sectors, to improve supply-side conditions and ease inflationary pressures.
• The government and the RBI should work together to ensure smooth market functioning and debt management. The government should adopt a realistic and flexible borrowing plan, while the RBI should use its various instruments to support the bond market and ease the yield curve.
• The government and the RBI should also monitor global developments closely and be prepared to take appropriate measures to mitigate any adverse shocks or spillovers. The government and the RBI should also strengthen their cooperation with other countries and multilateral institutions to address common challenges and opportunities.

Conclusion

• The RBI's decision to maintain the status quo on interest rates reflects the central bank's cautious approach to managing inflation while supporting economic growth. India needs to address the challenges of inflation and monetary transmission while staying vigilant about external economic risks to ensure sustainable and stable economic growth.

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Monetary policy committee highlights: https://iasgyan.in/daily-current-affairs/monetary-policy-committee-highlights

Rbi’s Repo Rate Pause: https://www.iasgyan.in/daily-current-affairs/rbis-repo-rate-pause