Home Business framework RBI deploys less-noticed smart measures to stave off geopolitical risks

RBI deploys less-noticed smart measures to stave off geopolitical risks

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NEW DELHI: The economic sky is clearly overcast, clouded by tensions in Europe. India faces prospects of weaker growth and higher than expected inflation, according to the “April 2022 Review” from the Reserve Bank of India (RBI).

It is against this background that many analysts believe that RBI needs to raise interest rates significantly to control inflation, but appear to be lagging “behind the curve”.

Instead, RBI decided to maintain its main key rates – the repo and the reverse repo on April 8.

Central banks’ main mandate is to fight inflation, while governments still want easy policy rates to fuel growth. There is a perception that RBI was always pursuing growth by pumping more money into the economy, instead of inflation by raising interest rates.

However, a closer look at the RBI liquidity framework announced last week and the April review show that the central bank has not undermined emerging risks. He actually took smart steps, considering the risks of war in Ukraine, the breakdown of global supply chains and rising prices.

Let’s look again at the numbers that matter:

GDP: RBI forecast real (inflation-adjusted) gross domestic product (GDP) growth of 7.2% for FY 2022/23, lower than the previous forecast of 7.8%. GDP is a measure of production and the broadest measure of national income.

Prices: The central bank expects inflation to rise sharply to 5.7% from 4.5% expected in February.

Policy rates: despite the risks of lower growth and higher inflation, the six-member Monetary Policy Committee (MPC) voted to maintain the repo (lending rate) and reverse repo (borrowing rate) stable at 4% and 3.5% respectively.

These rates are key to boosting business credit, borrowing and investment in the economy as India continues its nascent economic recovery. The MPC’s review of the economy is critical for markets and general business sentiment. Lower rates, which increase the money supply, make it easier for both government and businesses to borrow, thereby stimulating growth.

Yet, although it did not raise these rates (to control inflation), the RBI did change its liquidity framework or general money supply policy. This is the core of RBI’s new policy stance, which now leans toward the “hawk.”

RBI has launched a 3.75% Standard Deposit Facility (SDF) for the first time. Note that this 25 basis points below the overall repo rate will allow the central bank to withdraw money from banks, thus absorbing liquidity and reducing the money supply. This obviously aims to fight against inflation.

This decision alone also made the reverse repo rate (borrowing rate) almost redundant although it was unchanged.

The Marginal Standing Facility (MSF) rate – the rate at which RBI lends overnight funds to scheduled banks – has been set at 4.25% in case RBI deems it necessary to increase the money supply , which is unlikely given the high inflation.

Former World Bank chief economist Kaushik Basu in a tweet on Sunday said RBI’s new policy stance was a “smart move”. He said RBI decisions now require “complementary policies from the government. “Without these, I think inflation will get worse.”


  • ABOUT THE AUTHOR

    Zia Haq reports on public policy, economics and agriculture. Particularly interested in development economics and growth theories.
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