Monetary and Credit Policy April 2022

The Monetary Policy Committee (MPC) met on 6th, 7th and 8th April 2022 and, based on an assessment of the macroeconomic situation and the outlook, voted unanimously to keep the policy repo rate unchanged at 4 per cent. The MPC also decided unanimously to remain accommodative while focusing on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth.

Monetary policy refers to the use of monetary instruments under the control of central bank to regulate magnitudes such as interest rates, money supply and availability of credit with a view to achieving the ultimate objective of economic policy.

The Reserve Bank of India (RBI) is vested with the responsibility of conducting monetary policy. This responsibility is explicitly mandated under the Reserve Bank of India Act, 1934. Under the amended RBI Act, the monetary policy making is as under: (a) The MPC is required to meet at least four times in a year. (b) The Flexible Inflation Targeting Framework (FITF) was introduced in India post the amendment of the Reserve Bank of India (RBI) Act, 1934 in 2016. In accordance with the RBI Act, the Government of India sets the inflation target every 5 years after consultation with the RBI.

Highlights of the April Monetary Policy

• In its latest meeting during April 6-8, the Monetary Policy Committee (MPC) firmed up its latest monetary policy stance. The MPC decided to remain accommodative while focusing on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth.
• The MPC has retained the repo rate or the short-term lending rate at 4 per cent and the reverse repo rate, the rate at which the RBI borrows money from the banks in the short term to 3.35 per cent, continuing with the accommodative stance on expected lines. The repo rate or the short-term lending rate was last cut on May 22, 2020. Since then, the rate remains at a historic low of 4 per cent.
• In the latest MPC monetary policy stance, the marginal standing facility (MSF) rate and the Bank rate remain unchanged at 4.25 per cent.
• Further, it has been decided by the Reserve Bank to restore the width of the Liquidity Adjustment Facility (LAF) corridor to 50 basis points, the position that prevailed before the pandemic.
• The floor of the corridor will now be provided by the newly instituted standing deposit facility (SDF), which will be placed 25 basis points below the repo rate, i.e., at 3.75 per cent.

Additional measures

The MPC also announced some additional measures under the monetary policy statement. They are as follows:

1. Individual Housing Loans – Rationalisation of Risk Weights- The risk weights for individual housing loans were rationalised in October 2020 by linking them only with loan to value (LTV) ratios for all new housing loans sanctioned up to March 31, 2022. Recognising the importance of the housing sector and its multiplier effects, it has been decided to extend the applicability of these guidelines till March 31, 2023.This will facilitate higher credit flow for individual housing loans.
2. SLR holdings in HTM category– With a view to enable banks to better manage their investment portfolio during 2022-23, it has been decided to enhance the present limit under Held to Maturity (HTM) category from 22 percent to 23 per cent of NDTL till March 31, 2023. It has also been decided to allow banks to include eligible SLR securities acquired between April 1, 2022 and March 31, 2023 under this enhanced limit. The HTM limits would be restored from 23 per cent to 19.5 per cent in a phased manner starting from the quarter ending June 30, 2023.
3. Discussion Paper on Climate Risk and Sustainable Finance– Climate change poses certain risks that could have implications for the safety and soundness of financial institutions and as well as financial stability. To facilitate better understanding and assessment of the potential impact of climate-related financial risks by Regulated Entities, a Discussion Paper on Climate Risk and Sustainable Finance will be published shortly for feedback.
4. Committee for review of Customer Service Standards in RBI Regulated Entities– The Reserve Bank has over the years taken a number of measures to enhance consumer protection. These measures include laying down regulatory frameworks on customer service, internal grievance redress and the Ombudsman mechanisms. In view of the transformation underway in the financial landscape due to innovations in products and services, deepening of digital penetration and emergence of various service providers, it is proposed to set up a committee to examine and review the current state of customer service in the RBI Regulated Entities, adequacy of customer service regulations and suggest measure to improve the same.
5. Interoperable Card-less Cash Withdrawal at ATMs-At present, the facility of card-less cash withdrawal through ATMs is limited only to a few banks. It is now proposed to make card-less cash withdrawal facility available across all banks and ATM networks using the UPI. In addition to enhancing ease of transactions, the absence of the need for physical card for such transactions would help prevent frauds such as card skimming, card cloning, etc.
6. Bharat Bill Payment System: Rationalisation of Net-worth Requirement for Operating Units– Bharat Bill Payment System (BBPS), an interoperable platform for bill payments, has seen an increase in the volume of bill payments and billers over the years. To further facilitate greater penetration of bill payments through the BBPS and to encourage participation of a greater number of non-bank Bharat Bill Payment Operating Units in the BBPS, it is proposed to reduce the net worth requirement of such entities from ₹100 crore to ₹25 crore.
7. Cyber Resilience and Payment Security Controls of Payment System Operators (PSOs)– Payment systems play a catalytic role in facilitating financial inclusion and promoting financial stability. To ensure that our payment systems remain resilient to conventional and emerging risks, specifically those relating to cyber security, it is proposed to issue guidelines on Cyber Resilience and Payment Security Controls for Payment System Operators.

Assessment of Growth and Inflation

Growth

The post- Covid-19 pandemic growth momentum is expected to be moderated due to impact of Ukraine war on commodity prices, especially fuel, food and other inputs including raw materials and financial market, merchandise trade and global economic growth. Taking all these factors into consideration, real GDP growth for 2022-23 is now projected at 7.2 per cent with Q1:2022-23 at 16.2 per cent; Q2 at 6.2 per cent; Q3 at 4.1 per cent; and Q4 at 4.0 per cent, assuming crude oil (Indian basket) at US$ 100 per barrel during 2022-23.

The MPC said that the Indian economy is steadily reviving from its pandemic induced contraction with the second advance estimates released on February 28, 2022 by the National Statistical Office (NSO) putting the real GDP growth at 8.9 per cent in 2021-22. But it expressed concern that private consumption and fixed investment – key drivers of domestic demand remain subdued, with these two components being only 1.2 per cent and 2.6 per cent respectively, above their pre-pandemic levels. On the supply side, contact-intensive services still trail the 2019-20 level.

MPC has attributed escalating geopolitical tensions responsible for moderation of economic outlook of the country from the February outlook saying that trade exposure of India to the countries at the epicentre of the conflict is limited, but the war could potentially impede the economic recovery through elevated commodity prices and global spillover channels. Further, financial market volatility induced by monetary policy normalisation in advanced economies, renewed COVID-19 infections in some major countries with augmented supply-side disruptions and protracted shortages of critical inputs, such as semi-conductors and chips, pose downside risks to the outlook.

Inflation

The Monetary Policy Committee raised the inflation forecast for the fiscal year to 5.7% percent, from 5.5 percent citing rising commodity prices. The committee noted the recent spike in inflation. The headline CPI inflation edged up to 6.0 per cent in January 2022 and 6.1 per cent in February, breaching the upper tolerance threshold.

Pick-up in food inflation contributed the most to headline inflation, with inflation of cereals, vegetables, spices and protein-based food items like eggs, meat and fish being the key drivers.

Fuel inflation moderated on continuing deflation in electricity and steady LPG prices. Core inflation, i.e., CPI inflation excluding food and fuel remained elevated, though there was some moderation from 6.0 per cent in January to 5.8 per cent in February primarily due to the easing of inflation in transport and communication; pan, tobacco and intoxicants; recreation and amusement; and health, the committee noted.

Although the February 2022 meeting of the MPC had projected a moderating path for inflation during 2022-23, heightened geopolitical tensions since end-February have  upended the earlier narrative and considerably clouded the inflation outlook for the year. On the food price front, a likely record Rabi harvest would help to keep domestic prices of cereals and pulses in check. Global factors such as the loss of wheat supply from the Black Sea region and the unprecedented high international prices of wheat could, however, put a floor under domestic wheat prices. Edible oil price pressures are likely to remain elevated in the near-term due to export restrictions by key producers as well as loss of supply from the Black Sea region. Feed cost pressures could continue due to global supply shortages, which could also have a spillover impact on poultry, milk and dairy product prices.

Coming to non-food items, the spike in international crude oil prices since end-February poses substantial upside risk to inflation through both direct and indirect effects. Sharp increase in domestic pump prices could trigger broad-based second round price pressures.

A combination of high international commodity prices and elevated logistic disruptions could aggravate input costs across agriculture, manufacturing and services sectors. Their pass-through to retail prices, therefore, warrants continuous monitoring and pro-active supply management. Financial markets are likely to remain volatile on rising risk premia, dislocations in trade and capital flows and divergent monetary policy responses across central banks. Taking into account these factors and on the assumption of a normal monsoon in 2022 and average crude oil price (Indian basket) of US $ 100 per barrel, inflation is now projected at 5.7 per cent in 2022-23, with Q1 at 6.3 per cent; Q2 at 5.8 per cent; Q3 at 5.4 per cent; and Q4 at 5.1 per cent.

Outlook: Mixed Picture reflected by high frequency indicators

During 2021-22, weakness in economic activity resurfaced in Q3 and got exacerbated by the emergence of the Omicron variant in January 2022. A gradual turnaround has been noticed during February, although in March 2022 a mixed picture was seen. Some contact-intensive activities have regained traction amidst declining infections and removal of restrictions. Several high frequency indicators – railway freight; GST collections; toll collections; electricity demand; fuel consumption; and imports of capital goods posted robust year-on-year expansion during February-March. With the easing of restrictions, domestic air passenger traffic rebounded in March. According to our surveys, consumer confidence is improving and households’ optimism in outlook for the year ahead has strengthened with an uptick in sentiments. Business confidence is in optimistic territory and supportive of revival in economic activity. On the other hand, passenger vehicle sales and registrations continue to contract, though at a moderating pace. Both manufacturing and services PMIs remain in the zone of expansion; while manufacturing PMI moderated slightly in March, services and composite showed improvement.

Going forward, robust Rabi output should support recovery in rural demand, while a pick-up in contact-intensive services should help in further strengthening urban demand. Investment activity may gain traction with improving business confidence, pick up in bank credit, continuing support from government capex and congenial financial conditions. Capacity utilisation (CU) in the manufacturing sector recovered further to 72.4 per cent in Q3:2021-22 from 68.3 per cent in the previous quarter, surpassing the pre-pandemic level of 69.9 per cent in Q4:2019-20.

Prognosis

• The policy left key rates unchanged, however has introduced SDF ( standing deposit facility ) at 3.75% this effectively means the overnight rates will Have a floor of 3.75% ( rise by 40bps) This policy, in some sense, is a signal to tightening policy rates in the coming months.
• The RBI policy on keeping the repo rate unchanged reflects the need to balance growth vis – a – vis inflation.
• However, the RBI does not downplay the inflation risks and understands that the monetary policy will be less accommodative.
• RBI Governor Shaktikanta Das said, “With today’s measures RBI has moved to the path of gradual increase of policy interest rate and phased withdrawal of liquidity. From a medium term perspective, the measures are supportive of growth, price stability and orderly development in the financial markets” and added that the Reserve Bank will continue to adopt nuanced, nimble approach to liquidity management while ensuring adequate liquidity in system. The central bank will engage in gradual, multi-year withdrawal of Rs 8.5 lakh crore excess liquidity in system.
• Unlike the Western central banks which are tending towards a tight monetary policy to control inflation, the Reserve Bank of India it retained status quo on interest rates and kept the monetary stance accommodative. It’s a bold decision of the RBI to maintain the same interest rate while everyone around the world is increasing interest rates.
• This is aimed at beating a possible slowdown in economic activity due to geopolitical tensions while promising to keep a tab on inflation.
• The Governor rightly emphasized India’s macro strengths pointing to the improvement in the external situation helped by the record exports, ample forex reserves of $608 billion and strengthening of the financial sector. A new tool introduced by the central bank is the SDF (Standing Deposit Facility) to absorb liquidity. SDF will be the floor of the LAF corridor
• It may, however, be noted that given the excessive volatility in global crude oil prices since late February and the extreme uncertainty over the evolving geopolitical tensions, any projection of growth and inflation is fraught with risk, and is largely contingent upon future oil and commodity price developments.
• The approach of the central bank would be guided by the belief that the goal of price stability, sustained growth and financial stability are mutually.