Understanding Monetary Policy Stance - A layman point of view

 Monetary Policy Stance:

A layman's understanding

Monetary Policy Committee (MPC) of Reserve Bank of India (RBI) has set inflation control as their target (currently 4% with a tolerance level of +/-2%) and meets every two months to review and decide on (i) policy rate (repo rate) and (ii) monetary policy stance (stance) (parameters set for inflation control through monetary policy). Since Feb 2023, the repo rate is kept unchanged at 6.5% and the stance is "remaining focused on withdrawal of accommodation to ensure that inflation progressively aligns with the target, while supporting growth". 

While the right to set the repo rate and stance lies with MPC, implementation of the stance, however, rests with RBI. As a layman, I attempted to capture the few steps taken by RBI in achieving the stance since May 2022, (when they started raising the repo rate).

I. Withdrawing/tightening the accommodation measures, implemented as part of keeping the economy in float during COVID Period:

a. Cash Reserve Ratio (CRR): CRR is to be maintained by a bank with RBI and is not available for lending/investment purposes. This ratio, which was reduced from 4% to 3% of demand and time liabilities (DTL) in 2020-21, was restored  back to 4% in two phases of 50 bps each in 2021-22 and increased to 4.5% with effect from May 2022. The increase in May 2022 alone had the effect of impounding liquidity to the extent of Rs.1.38 lac cr. 

b. Funds lent to banks by way of LTRO/TLTRO allowed to mature without rollover: Long term repo operations/targeted long term operations (LTRO)/TLTRO) through which RBI lent funds to banks at repo rate (then at%) in 2020-21, for onward lending to eligible investments/sectors, since matured and the banks repaid the loans received from RBI. This had a liquidity drain out of more than Rs.1 lac cr. from the banking system.

c. MSF restored to pre-COVID levels:  Marginal Standing Facility (MSF),  a facility through which banks can borrow monies from RBI to meet daily liquidity mismatches, increased to 3% of  DTL during COVID period, is now back at 2% of DTL. Though MSF is drawn only to a limited extent by the banks, not exceeding 1% of their DTL at any point of time, the implication is that this window is at normal levels only, now.

d. Special Refinance facilities provided to All India Financial institutions (Rs.1.25 lac cr.) at repo rate for onward lending to banks since expired.

e. OMO-Purchase of securities, an accommodation to increase liquidity in banking system in 2020-21, is not resorted to during 2022-23 and 2023-24: RBI, which acquired Rs.1.92 lac cr. of government securities from the banking system through open market operations (OMO) and provided the much needed liquidity to banks in 2021-22 recently talked about introducing OMO -Sale of securities, so as to suck out liquidity from the banking system. So, this amounts to withdrawal of accommodation for liquidity.

II. Incremental CRR was introduced in August 2023 MPC meeting: RBI introduced incremental CRR of 10%, over and above the applicable CRR, in August 2023, which impounded a little over Rs. 1 lac cr. from the banking system.  However, this was withdrawn in two phases beginning 8th September 2023. Hence there is no impact to the banking system now. 

III. Through measures to ensure financial stability: In order to curtail growth in certain loan segments, which might have the effect of fueling inflation in addition to the possibility of increased delinquencies in the said loan segments later on, RBI recently increased the risk weights in respect of unsecured loans, credit card outstanding, loans to NBFCs etc. This measure is different from others as the measure is likely to have impact on consumer loans and spending thereof.

MPC Stance - No change likely: Since the excess liquidity in the banking system is no longer there, as evidenced by net borrowings by banks reaching Rs.2 lac cr. RBI on some days in November 2023, RBI may not impose further measures to impact the liquidity in the banking space. 

At the same time, it may not change the stance from withdrawal of accommodation to neutral since the following factors are still positive on the liquidity front.

(i) The impact of excess liquidity of Rs.3.5 lac cr. (app.) that came into the banking system through withdrawal of Rs.2000 bank notes from circulation, is still on.

(ii) System liquidity has got more evenly balanced among market participants as indicated by the balances in SDF (special deposit facility) and MSF (evening out the net LAF broadly)

(iii) The average call money rate is still ruling only a few bps over the MSF rate of 6.75%

(iv) Government spending has picked up (RBI Governor Statement on 8th December 2023), implying more liquidity into the banking system

Regards

V.Viswanathan

10th December 2023

Note: RBI Governor stated in his speech on 8th December 2023 that RBI has reduced its balance sheet size from 28.6% of GDP in 2020-21 to 23.3% of GDP in 2022-23. Though the balance sheet has grown in numbers, the reduction in terms of size to GDP can be mainly attributed to the reduction in the following heads in 2022-23, as compared to 2021-22. 

(i) Reverse repo balances maintained by banks (excess liquidity) coming down by Rs.3.0 lac cr. due to brisk credit take off in banks (after factoring the increase in CRR balances)  and 

(ii) Balances in government securities held by RBI (acquired mostly from OMO-purchases)  was less by Rs.82000 cr.



Comments

  1. Ramesh KrishnanDecember 10, 2023 at 2:28 AM

    Extremely well documented. Compliments.

    ReplyDelete
  2. SRKannanDecember 11, 2023 at 5:51 PM

    III i) Did not understand. 3.5 lac crore either with public or with bank should not impact liquidity.

    Title should be 'For A Layman's understanding'🤔

    ReplyDelete
    Replies
    1. AnonymousDecember 12, 2023 at 12:55 AM

      3.5 lac cr with public was not in circulation as per RBI own admission. Now it is deposited in banks. The public withdraws in other denominations and the money is now into the money in circulation. If it is kept as a deposit banks use it for lending and money supply with oublic goes up.

      Delete
  3. subbaramanDecember 13, 2023 at 3:15 AM

    Well articulated. Very precise 👌

    ReplyDelete

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