Practice affecting Monetary policy committee

Why in news?

The Reserve Bank of India’s Monetary Policy Committee (MPC) is set decide its policy stance in the coming days.

What were the outcomes of the previous meet?

• The monetary policy committee decided to increase the repo rate by 25 basis points to 6.5%.
• However, the RBI has maintained fairly a neutral policy stance.
• This means that RBI has made only a marginal increase which is proportionately lesser to the inflation projections.
• This was to help accommodate the domestic and external uncertainties like oil price rise, currency wars, US rate trajectory etc.,

Why there is a possibility of a rate hike now?

• U.S. Federal Reserve recently raised interest rates by 0.25%, which triggers concerns on outflow of portfolio investments from emerging markets.
• Hence the RBI would be expected to increase benchmark borrowing costs in India to prevent heightened outflows of portfolio capital.
• The rupee’s depreciation of more than 12% against the dollar in 2018 made imports costlier.
• Added with that, crude oil’s continuing upward march raised the risk of imported inflation.
• While headline CPI inflation eased appreciably in August to 3.69%, core inflation, which exclude the food, fuel and light groups, was still running higher at 5.59%.
• Food prices could also start hardening once the impact of the higher minimum support price for kharif crops kicks in.
• MSP hike may have a direct impact on food inflation and eventually on headline inflation (CPI).
• This will make things difficult for inflation-targeting mandate of RBI and will demand a tight policy (higher rates).
• All these factors make the argument for a rate hike even more compelling.

Why there is a possibility of reducing the repo rate?

• RBI recently has enhanced the "Facility to Avail Liquidity for Liquidity Coverage Ratio (FALLCR)" from the existing 11% to 13% of their deposits.
• The move follows RBI’s concerns over tight liquidity conditions and banks’ unwillingness to lend to NBFCs, following defaults by the IL&FS group.
• Liquidity Coverage Ratio refers to highly liquid assets which are held by financial institutions to meet short term obligations.
• The LCR promotes short-term resilience of banks to potential liquidity disruptions by ensuring that they have sufficient high quality liquid assets (HQLAs) to survive an acute stress scenario lasting for 30 days.
• Presently, the assets allowed as Level 1 High Quality Liquid Assets (HQLAs) for the purpose of computing LCR of banks include government securities in excess of the minimum SLR requirement.
• Within the mandatory SLR requirement, Government securities to the extent allowed by RBI under Marginal Standing Facility (MSF) currently stands at 2% of the bank's NDTL and under FALLCR is at 11% of the bank's NDTL.
• Now, banks will be permitted to reckon as Level 1 HQLAs, government securities held by them up to another 2% of their NDTL under FALLCR within the mandatory SLR requirement.
• It will take the total carve-out from SLR (statutory liquidity ratio) available to banks to 15% of bank’s NDTL.
• SLR is currently at 19.5%, which is the percentage of deposits that banks have to mandatorily invest in government and state government securities.
• The tweak to the LCR norms is expected to free up close to Rs. 2.5 lakh crore in additional liquidity to the banks.
• Out of that, Rs. 1.25 lakh crore becomes available to the banking system at the more affordable repo rate of 6.5%.
• Thus RBI is keen to reduce any risks to the availability and cost of short-term credit from any unforeseen financial market volatility.
• RBI has also conducted open market operations in successive weeks recently.
• It has provided a liberal infusion of liquidity through term repos in addition to the usual provision via the Liquidity Adjustment Facility.
• Thus, in order to mitigate tighter liquidity conditions on the domestic front, RBI might look forward to reduce the repo rates.

Source: The Hindu, Business Line