General Studies Paper 3
Context
- Recently, Monetary policy committee of the Reserve Bank of India has voted unanimously in its August meeting to keep the policy repo rate unchanged at 6.5 per cent.
- Alongside, the committee members voted 5-1 to keep the stance unchanged, focusing on the withdrawal of accommodation to ensure that “inflation progressively aligns with the target
Reason for maintaining the status quo of repo rate
- It will help in reaffirming the monetary policy objective of aligning inflation with the central bank’s target of 4 per cent Consumer Price Index (CPI) inflation with the upper tolerance limit of 6 per cent and the lower tolerance limit of 2 per cent.
- However, considering that the requirement for a policy response at this juncture is curtailed due to a supply-side induced spurt in food inflation and a moderation in core inflation, it would seem that the MPC is likely to maintain status quo on rates in the near term.
What is the Inflation target?
- Under the Under Section 45ZA of RBI act1934, the Central Government, in consultation with the RBI, determines the inflation target in terms of the Consumer Price Index (CPI), once in five years and notifies it in the Official Gazette
- Under which Central Government notified in the Official Gazette 4 per cent Consumer Price Index (CPI) inflation as the target for the period from August 5, 2016 to March 31, 2021 with the upper tolerance limit of 6 per cent and the lower tolerance limit of 2 per cent.
- On March 31, 2021, the Central Government retained the inflation target and the tolerance band for the next 5-year period – April 1, 2021 to March 31, 2026.
- Section 45ZB of the RBI Act provides for the constitution of a six-member Monetary Policy Committee (MPC) (which is headed by RBI governor) determine the policy rate required to achieve the inflation target.
- Therefore, Inflation target is set by central government and it is maintained by RBI through monetary policy tools.
However, The trajectory of inflation unpredictable.
- In its June policy, the RBI had projected it at 5.2 per cent in the second quarter. In its August meeting, it substantially revised its projection upwards to 6.2 per cent as prices of vegetables have soared in July and August.
- While this surge is likely to be temporary — the commentary from the RBI does suggest that the central bank believes that vegetable prices will correct in the near term there remains considerable ambiguity over food prices on account of uncertainty over the distribution of monsoon and impact of El Nino.
- During such periods, as the RBI Governor has underlined, “supply side interventions” can limit the “severity and duration of such shocks”
- Recently, Union food ministry announced that it was offloading 50 lakh metric tonnes of wheat in the open market in a phased manner. This could have a moderating influence on prices
- However, other factors, such as higher crude oil prices, also pose risks to the trajectory of inflation. The central bank has now revised upwards its full year inflation forecast to 5.4 per cent, from 5.1 per cent earlier.
- Alongside, it has also taken steps to absorb the surplus liquidity generated by the return of the Rs 2,000 notes to the banking system by imposing an incremental cash reserve ratio of 10 per cent.
It is necessary to maintain growth while controlling the inflation
- On the growth front, the RBI remains optimistic, expecting the economic momentum to continue.
- The central bank has retained its forecast for GDP growth this year at 6.5 per cent, even as external demand weakens and the cumulative rate hikes of 250 basis points are still working their way through the system.
- However, considering the uncertainty in the global economy, the central bank must remain vigilant on all fronts. While it has done well to look through this spurt in inflation, it must be cautious.
- As the governor’s statement also acknowledges, “frequent incidences of recurring food price shocks, however, pose a risk to anchoring of inflation expectations”.
- The future course of monetary policy will be influenced by how growth and inflation evolve over the coming quarters.
Conclusion
- Therefore, while consider the global economic situation and food-based inflation, the stand of Monetary policy committee to unchanged repo rate will help in controlling inflation along with maintaining the economic growth.
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