The Reserve Bank of India (RBI) is about to announce its monetary policy.
What is a Monetary Policy?
Monetary policy is the process by which the RBI controls the supply of money, often targeting an inflation rate or interest rate to ensure price stability.
RBI reviews its monetary policy every two months.
The RBI implements the monetary policy through open market operations, bank rate policy, CRR, SLR, reserve system, credit control policy, moral persuasion etc.
Using any of these instruments will lead to changes in the interest rate, or the money supply in the economy.
Increasing money supply and reducing interest rates indicate an expansionary monetary policy. The reverse of this is a contractionary monetary policy.
What are the key issues to be addressed?
Rate cut - The RBI has consistently kept the interest rates low in the last two monetary policy announcements.
The market expects the repo rate to be reduced by 25 basis points (bps) to 6%. One bps is a hundredth of a percentage point.
But there is also an another argument that due to demonetisation the interest rates are already low and therefore repo rate should remain unchanged to boost savings.
Therefore RBI’s any move regarding this should be accompanied by stating the proper reasoning behind it.
Inflation - Retail inflation decelerated to a two-year low of 3.41% in December as vegetable prices continued to fall.
RBI is aiming to keep retail inflation under 5% in the fourth quarter and 4% within a band of 2 percentage points on either side in the medium term.
The RBI’s assessment of the inflation situation would be crucial to understand all future rate movements.
Demonetisation impact - This is the second RBI monetary policy announcement since demonetisation.
In the last monetary policy announcement, RBI did not clarify the impact of demonetisation on growth in India.
It is crucial to find out the real consequences of removing 86% of currency notes by value from circulation. Data points about the total deposits acquired by banks during the 50-day period and the number of new currency notes pushed back into the banking system should be given out.
MPC decisions -All six members of the Monetary Policy Committee (MPC) have consistently taken an unanimous monetary policy decision.
Therefore it would be important to see if all six votes are in favour of a rate cut or a pause.
Commentary on sectoral issues - The banking regulator has not made any major announcements around banking sector issues such as capital and asset quality since the demonetisation announcement.
The former RBI governor Raghuram Rajan chose March 2017 as deadline for banking sector’s bad loan trouble.
