Reserve Bank of India (RBI) Monetary Policy Decision, August 6, 2021

The RBI on August 4,2021 decided to keep its present monetary policy stance unchanged.

• Policy rates corridor of 3.35% (overnight reverse repo rate) and 4.00% (overnight repo rate) under Liquidity Adjustment Facility (LAF)

• The marginal standing lending facility and the Bank Rate at 4.25%

• Accommodative stance to revive and sustain growth on long-term basis to mitigate the Corona impact on the economy.

Present Policy Background

    As the immediate response to the pandemic, the RBI activated a significant package of monetary accommodation as highlighted below.

• 18 March 2020 - Term purchase of govt. securities of Rs. 1 tn. to inject liquidity.

• 27 Mach 2020 - reduced the repo rate by 75 basis points to 4.4%, reverse repo rate by 90 basis points to 4.0%.

• 17 April 2020 – reduced the reverse repo rate by 25 basis points to 3.75%

• 22 May 2020 – reduced reverse repo rate to 3.35% from 3.75%, repo rate by 0.40% to 4.4%, Marginal standing facility rate and the Bank Rate reduced to 4.25% from 4.65%.

• Conducted auctions on regular basis to inject funds on term basis.

• Relaxed bank credit regulations significantly to promote credit delivery.

• Inflation (consumer) target 4% (Annual) medium-term with a band of +/-2% as pre-pandemic position.

Decision Background

• Present inflation is 6.3% in June 2021.

• Ample liquidity in the inter-bank market due to purchase of foreign exchange and pandemic injection of liquidity through term-repo auction.

• Partly due to slow credit growth out of abundant liquidity, daily absorption under the LAF/overnight reverse repo increasing from ₹ 5.7 tn. in June to ₹ 6.8 tn. in July and to ₹ 8.5 tn. up to August 4, 2021.

• As of July 16, 20201, money supply M3 and bank credit rose low by 10.8% and 6.5%.

• Money printing has increased by 24.4% by the end of July 2021 since the end of March 2020 (from ₹ 30.1 tn. to ₹ 37.2 tn.), mainly through credit to the state and purchase of foreign exchange.

• India’s foreign exchange reserves increased by US$ 43.1 bn in 2021-22 up to end-July to US$ 620.1 billion.

General Comments on Global Monetary Policies

• RBI’s policy slogan is similar to other central banks followed by the US Fed, BoE and ECB.

• The pandemic monetary policy model has been to pump liquidity to the inter-bank market primarily by buying government securities at higher prices (lower yields under the present ultra-loose monetary policy) with significant capital gains to banks.

• This abundant liquidity has helped governments to finance their huge budget deficits on account of fiscal stimulus to businesses and households affected by the Corona pandemic at historic low-interest rates. That has helped boost aggregate demand to revive supply chains to some extent while helping the public to overcome enormous difficulties connected with the pandemic.

• However, given huge credit risks due to pandemic-related uncertainties, bank lending to the private sector has been at historic lows, resulting in a huge volume of excess funds created in the banking system out of the ultra-lose monetary policies.

• Therefore, almost all central banks have failed to innovate their monetary policy models to facilitate the recovery of social and economic lives of the public out of new funds. Therefore, in the present inter-bank liquidity-based policy models, banks are recycling the excess liquidity back to central banks for interest income. Only ECB and few central banks adopt negative interest rates (negative 0.50% in the ECB) to charge and discourage banks from such recycling of excess liquidity.

• Although the US Fed follows several sectoral credit facilities aggressively targeted for the recovery of identified credit markets and businesses, liquidity overhang has become a system problem in the US too.

• All central banks now talk about the present trend of inflation uprise as transitory and rising fiscal deficits and debt are not concerns at present in view of the pandemic policy package necessary and they view that any concerns including inflation surge, if permeant, can be addressed once the economies are recovered from the pandemic. The Fed and ECB amended their definition of the inflation target to consider medium or longer-term inflation in order to facilitate the monetary accommodation unaffected by the inflation surge.

• However, monetary policies globally have failed to streamline credit to businesses and households as central banks do not think out of the present model of inter-bank liquidity and overnight interest rate targets which are not appropriate for the present pandemic-hit-world. Therefore, their expectation to recover from the pandemic with emerging new variants and waves across the globe only through the fiscal front assisted by the monetary policy coordination (money printing at historic low interest rates) with the present monetary policy model will take a longer time for the recovery. The people have to suffer from such policy lethargy.

• Further, this inflation target-based policy model will not be appropriate for countries like India as monetary measures have no control over market prices, given huge bureaucratic red tapes that control market forces and the price mechanism.

• Therefore, central banks globally have to invent new policy models to revive businesses, households and supply chains across the globe if they are seriously concerned about their public mandates and the recovery of the people from the present pandemic impact that requires flows of money and credit.