RBI Monetary Policy In February 2024

The decision on RBI Monetary policy in February 2024 came out recently (here). We’re here to break down the key points in simple words that even beginners can understand and comprehend. The RBI’s Monetary Policy Committee (MPC) kept the policy repo rate unchanged at 6.5%.

– What is the Repo Rate?

It is the interest rate at which RBI lends short-term money to commercial banks against government securities. Imagine banks borrowing from the RBI. It is like we taking a bank loan. The Repo Rate is the “interest” on that loan. When the rate is high, borrowing is expensive, potentially slowing the economy. Conversely, a low rate encourages borrowing and spending, boosting growth. RBI uses the Repo Rate as a key tool to manage inflation and maintain financial stability.

The repo rate influences interest rates in the whole Indian economy. The committee (MPC) also decided to maintain a stance called “withdrawal of accommodation” to keep inflation in check.

Look at the historical repo rate of RBI since the year 2005.

– What does RBI mean by “withdrawal of accommodation”?

The Reserve Bank of India (RBI) used the term in its report called the “withdrawal of accommodation.” In the context of monetary policy, it refers to a shift in RBI’s stance from being accommodative to becoming less accommodating or more restrictive.

  • Accommodative monetary policy is characterized by lower interest rates and a more lenient approach to liquidity in the financial system. It is implemented to stimulate economic activity, encourage borrowing, and boost spending. When RBI decides to withdraw accommodation, they are moving away from this supportive policy stance.

In practical terms, “withdrawal of accommodation” often involves increasing interest rates or adopting measures to reduce the availability of money in the financial system. By doing so, the central bank aims to control inflation and prevent the economy from overheating.

Inflation occurs when too much money is in circulation, leading to rising prices of goods and services. To counter this, RBI may decide to tighten monetary policy by increasing interest rates.

What is causing the liquidity tightening?

The decision to keep rates steady aligns with expectations. The committee (MPS) aims to be watchful due to volatile food prices and the ongoing process of controlling inflation. This means they want to make sure the economy is stable and not experiencing rapid price increases.

RBI manages the liquidity. It means that it is controlling the amount of money circulating in the financial system. They’ve used tools like Variable Reverse Repo Rate (VRRR) auctions to keep the money market rates close to the policy repo rate of 6.5%.

– What is Variable Reverse Repo Rate (VRRR)?

The Variable Reverse Repo Rate (VRRR) is a tool of RBI to absorb excess cash in the banking system.

Unlike the fixed Repo Rate, VRRR is flexible and is set through auctions. Banks offer funds to the RBI at this rate. A higher VRRR incentivizes more deposits, reducing liquidity and potentially curbing inflation. It complements the Repo Rate, giving the RBI more control over money supply management.

What happens when VRRR is close to the policy repo rate (say 6.5%)?

When the Variable Reverse Repo Rate (VRRR) is close to the policy repo rate (currently 6.5%), it signifies that the RBI is actively absorbing excess liquidity from the banking system. This proximity can have several consequences:

  • Reduced interbank lending: Banks become less likely to lend to each other at rates close to the VRRR. Why? Because at VRRR they have the option to lend money to RBI itself, which will be a much safer bet. By setting VRRR near to repo rate, RBI is potentially limiting access to credit and slowing economic activity.
  • Tighter money supply: With less liquidity, banks have less capacity to create new money. Imagine our economy is a pool. The VRRR is like scooping water out (excess cash). This leaves less water in the pool (less liquidity). When there is less money with banks they cannot give as many loans. This can slow down overall economic growth (a way to suppress inflation).
  • Signal for future policy: A VRRR close to the repo rate might indicate the RBI’s intention to raise the repo rate in the future to further control inflation. It can potentially impact borrowing costs and investment decisions.

What is the RBI’s view on Inflation in 2024?

The RBI expects the Consumer Price Index (CPI) to be 5.4% for the fiscal year 2024. The RBI has also projected CPI to be at 4.5% in 2025.

– What Consumer Price Index (CPI)

Think of the CPI as a giant shopping basket containing a representative selection of goods and services that people typically buy. The RBI tracks the price changes of these items every month.

By comparing the cost of this basket over time, the RBI calculates the percentage change in prices, which reflects the inflation rate.

– What is inflation?

Inflation measures how much the prices of goods and services are increasing, affecting your purchasing power. Imagine our lunch fund buys a pizza slice each day. Now, imagine all prices slowly start to rise. In a condition when our lunch funds remain the same, it will be able to buy only half a slice! That’s inflation – the value of your money shrinks over time. It can make things cost more and more.

Why does this happen? This can happen when there’s too much money floating around. More people are using this easy money (liquidity) to buy goods and services. This increased demand is causing the costs of goods and services to increase.

What is the RBI’s view of GDP Growth in 2024?

The RBI projects a 7% real GDP growth in 2024. This positive outlook is fueled by robust manufacturing, and healthy bank and corporate balance sheets. The government’s focus on capital expenditure will also give a nice push to the GDP growth rate.

– What is GDP and GDP growth?

Think of our country as a giant bakery that sells only cakes and cookies as its products. GDP, or Gross Domestic Product, is the total value of all those “products” sold in a year. It captures the size of the economy.

Now, imagine the bakery sells 10% more products next year. That increase is the GDP growth rate. It tells you how fast the economy (of the bakery) is expanding.

Both GDP and its growth rate are key indicators of a nation’s economic health.

Policies of RBI To Regulate Gold Prices

The RBI has introduced some changes. Resident entities can now engage in over-the-counter gold price hedging within the International Financial Services Centre (IFSC). This move aims to provide more options for managing gold price risk and increasing liquidity in the gold market.

– What is over-the-counter gold price hedging?

Imagine you want to buy gold for your jewelry shop but are worried that its price might drop. Before, you couldn’t protect yourself against this in some ways. Now, the RBI allows businesses like yours to use special contracts within a special financial zone (IFSC) to “hedge” against price changes.

Think of it like an insurance policy for your gold. If the price falls, you still get some money back. This helps businesses manage risk and makes the gold market more active.

RBI on borrowers of all retail and MSME loans

The RBI has mandated regulated entities to provide borrowers of retail and MSME loans with a “Key Fact Statement,” offering critical information on loan terms. This is a step towards transparency in lending practices.

– What the RBI is trying to say & do with this policy?

  • #1. Key Fact Statement for Loans: Imagine you want to borrow money for your business or your home. Now, you’ll get a clear “Key Fact Statement” with all the costs and details upfront. The details will be like interest rates, fees, and repayment terms. This will help you to understand the loan better and make a right decision.
  • #2. Faster and Safer Banking Access: This policy might also make opening a bank account through our phone (AePS) easier and safer. Imagine it as if you are getting into a bank like HDFC Bank private bank instead of SBI where hassles are less even though the safety of funds is equally great. This can help more people join the financial system.
  • #3. Secure Digital Payments: Paying online could get more secure with new ways to verify who you are (like a more stringent KYC), even without your password.
  • #4. Digital Cash with More Uses: India’s digital cash experiment (CBDC) might allow businesses to do more with it in rural areas. How? CBDC transactions can happen even without the Internet. Imagine using CBDC like regular cash, even when your phone has no signal. Know more about CBDC here.

These policies aim to make borrowing cheaper and clearer. If banking is easier and safer and online payments more secure, people are more likely to switch from paper currency to CBDC.

How is the RBI’s Overall Tone

The RBI’s tone in its recent statement is considered hawkish. It indicates a vigilant approach toward controlling inflation. They are committed to the 4% inflation target and maintaining flexibility in managing liquidity.

The RBI’s monetary policy decisions aim to strike a balance between economic growth and inflation control.

The committee is focused on maintaining stability, transparency, and flexibility in managing liquidity.

Conclusion

The good news: RBI has decided to keep interest rates the same for now. It will help businesses and people borrow money easily. This could boost the economy. It is also good news for stock investors as cheaper debt means more spending and hence growth.

The not-so-good news: Prices are rising a bit faster than the RBI likes. They’re worried about things like expensive oil and global instability making it worse. For stock investors like us, it’s a kind of scary situation when “interest rates” are low and RBI is getting worried about “inflation.” In such situations, one must invest with caution as big corrections might happen when interest rates start to go up.

But this is also true that the RBI wants to help the economy grow without letting prices get out of control. It’s like walking a tightrope. Also, with the Lok-Sabha elections being only a few months away, RBI’s hesitancy to increase the repo rate is obvious and understandable.

Have a happy investing.

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