Daily News Analysis

RBI’s Monetary Policy

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RBI’s Monetary Policy

 

 

Why in the News?

The Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) maintained the status quo on interest rates during its review meeting in October.

The RBI prefers higher rates for longer periods for both domestic and external reasons:

  1. External factors include:
    1. Higher US inflation rates (they had to ease monetary policy rapidly to fight an economic collapse, and then hike repeatedly to tame inflation)
    2. Disruption in global supply chain
    3. Russia-Ukraine War
    4. Weakening global economy
    5. Rise in crude oil prices 
  2. Domestic factors include:
    1. Inflation in food items
      1. Tomato-led surge in vegetable inflation spiked the consumer price index to 7.4% in July.
    2. Volatile and rising crude oil prices
    3. The past rate hikes of 250 basis points since May 2022 to bank lending and deposit rates remains incomplete.

About:

Surge in Retail Inflation:

  1. Caused due to rise in food prices particularly cereals, pulses, milk and tomato.
  2. Rice prices on rise has led to export restrictions being announced by the central Government, caused due to extreme flooding and deficit rainfall in different parts of the country affecting the yield.
  3. The rise in inflation shall push RBI to adopt a hawkish stance and delay on interest rate cuts that have been put on place.

What is Inflation?

It is defined as the ‘Persistent rise in general price levels in an economy over a period of time’.

Factors causing Inflation:

Demand pull Inflation

Cyclic factors causing Inflation

  1. Increase in purchasing power of the people
  2. Rise in population
  3. Change in tastes and preferences of the consumers.

 

Cost-push inflation

Structural factors causing inflation

  1. Lack of Factors of Production (Land, Labour, capital and entrepreneurship)
  2. Government policies like Labour laws making prices costly.
  3. Natural Disasters
  4. Devaluation of Currency
  5. Lack of Infrastructure.

 

Types of Inflation indexes:

 

Wholesale Price Index (WPI)

Consumer price Index (CPI)

1.

Tracks inflation at producer level

Tracks inflation at Consumer level

2.

Doesn’t capture changes in prices of services (only goods)

Captures changes in prices of goods and services

3.

More weightage given to manufactured goods

More weightage given to food items

4. 4.

Published by the Office of Economic Adviser, Ministry of Commerce and Industry.

 

Four types of CPI are as follows:

  • CPI for Industrial Workers (IW).
  • CPI for Agricultural Labourer (AL).
  • CPI for Rural Labourer (RL).
  • CPI (Rural/Urban/Combined).

first three are compiled by the Labour Bureau in the Ministry of Labour and Employment and the fourth is compiled by the Central Statistical Organisation (CSO)

 

5.

Base year: 2011-12

Base year: 2012

6.

Calculated monthly and weekly for primary goods, fuel and electricity

Calculating monthly.

 

How is Inflation calculated in India:

  1. The Monetary policy Committee of India uses CPI data to fix the inflation rate in India.
  2. RBI adopted CPI as its key measure of inflation in 2014 based on Urjit Patel Committee recommendation.
  3. The MPC is a statutory and institutionalized framework under the RBI Act, 1934 for maintaining the price stability and growth.
  4. The MPC Committee consists of:
    1. Governor of RBI – Ex-officio chairman
    2. Three other officials of RBI
    3. Three external members nominated by the Government of India.
  5. The MPI determines the policy interest rate (repo rate) required to attain the Inflation target of 4% with an upper tolerance limit of 6% and a lower limit of 2%.

RBI measures to control Inflation:

  1. Contractionary monetary policy to decrease the money supply and resultant demand in the economy.
  2. Increase in
    1. Cash Reserve Ratio
    2. Statutory Liquidity Ratio
    3. Repo rate
    4. Reverse Repo rate

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