Table of Contents
The News
- For the 11th time in a row, the Reserve Bank of India (RBI) has decided to keep the main policy rate – repo rate – unchanged at 4%.
- It has also retained its accommodative stance, but indicated it will engage in a gradual and calibrated withdrawal of surplus liquidity to rein in inflation.
- RBI has also introduced new mechanism of Standing Deposit Facility to absorb excess liquidity.
Why Inflation a concern?
- In the wake of the rise in crude oil and commodity prices and the impact of the Russian invasion of Ukraine, RBI has slashed the growth forecast to 7.2% for fiscal 2022-23 from 7.8% projected earlier.
- Pleae note that India’s direct trade exposure to the countries at the epicentre of the conflict is limited but the war could potentially impede the economic recovery through elevated commodity prices and global spill-over channels.
- Also, financial market volatility induced by monetary policy normalisation in advanced economies, renewed Covid-19 infections in some major countries with augmented supply-side disruptions and protracted shortages of critical inputs such as semiconductors and chips, pose downside risks to the outlook.
Why Inflation a concern?
- The RBI’s objective is to achieve the medium-term target for consumer price index (CPI) inflation of 4% within a band of ±2%, while supporting growth.
- Provisional CPI data for February released by the NSO showed that headline CPI inflation (year-on-year) for February 2022 edged up to 6.1% from 6% cent in January.
Why Inflation a concern?
Standing Deposit Facility
- Standing Deposit Facility was proposed to be introduced by the RBI as a collateral free liquidity absorption mechanism.
- (Why absorption needed? – RBI had injected huge liquidity during the Covid-19 pandemic through various measures.)
- Government in the Budget’s (2018) Finance Act included a provision for the introduction of the Standing Deposit Facility (SDF).
- Now, the RBI has introduced the Standing Deposit Facility (SDF) at an interest rate of 3.75%.
Understanding SDF
- In the present situation, the main arrangement for the RBI to absorb excess money with the banking system is the famous reverse repo mechanism. Under reverse repo, banks will get government securities in return when they give excess cash to the RBI. An interest rate of reverse repo rate is paid to the banks.
- The inconvenience with this arrangement is that the RBI has to provide securities every time when banks provides funds.
- As per the stand of the RBI, when the central bank has to absorb tremendous amount of money from the banking system through the reverse repo window, it will become difficult for the RBI to provide such volume of government securities in return. (RBI face that problem in 2016 at the time of demonetisation.)
- So now, the Standing Deposit Facility (SDF) is a collateral free arrangement meaning that RBI need not give collateral for liquidity absorption. The SDF will allow the RBI to suck out liquidity without offering government securities as collateral.
What to expect in near future?
- Long-term tightening of money supply can be anticipated..!!
- The RBI has said it will engage in a calibrated withdrawal of the accommodative stance over a multi-year time frame in a non-disruptive manner beginning this year. The objective is to restore the size of the liquidity surplus in the system to a level consistent with the prevailing stance of monetary policy.
- The liquidity measures undertaken in the wake of the pandemic, combined with liquidity injected through various other operations of the RBI, have left a liquidity overhang of the order of Rs 8.5 lakh crore in the system.
- For common man, the gradual tightening of money supply is expected to push up interest rates.
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