What’s in the news?

• The Monetary Policy Committee (MPC) of the RBI announced its decision to hold the benchmark repo rate unchanged at 4% and maintained an ‘accommodative’ policy stance.
• The central bank has slashed the repo rate by 115 basis points (bps) since late March to cushion the economy from the fallout of the COVID-19 crisis including the sweeping lockdowns to check the spread of the novel coronavirus.
• The RBI also brightened its outlook for the economy, projecting that the GDP contraction would narrow to 7.5% for the financial year ending in March 2021, a full 2 percentage points shallower than the 9.5% it had forecast in October. 
• The MPC noted that Consumer Price Index inflation would average 6.8% for Q3 and 5.8% in Q4 — both levels above or close to the 6% upper bound of the target range for ensuring price stability — before easing to a 5.2% to 4.6% range in the first half of the next financial year, starting April 2021.

How does India measure retail inflation?

• Inflation is the rate of change in the prices of a given set of items. India bases its retail inflation metrics on the Consumer Price Index (CPI). 
• The index records changes in prices for a sample of family budget items that are representative of what consumers typically spend their household income on — food, fuel, housing, clothing, health, education, amusement and even paan, tobacco and intoxicants. 
• The measure is based on a weighted average. That is, some items in the index may get greater weightage depending on their priority in a typical family’s budget. 
• The CPI-based retail inflation is measured monthly and is published as a percentage value of change in the index from the corresponding year-earlier period. 
• Data for a certain month are released by the Ministry of Statistics and Programme Implementation generally on the twelfth day of the subsequent month.

Why is faster inflation a concern for policymakers?

• Faster retail inflation is indicative of prices of household items rising quickly. While inflation affects everyone, it is often referred to as a ‘tax on the poor’ as the low-income stratum of society bears the brunt. 
• Persistent high inflation pushes several items out of reach for this category of consumers. 
• Over time, if unchecked, persistent high inflation erodes the value of money and hurts several other segments of the population, including the elderly living off a fixed pension. It hence ends up undermining a society’s consumptive capacity, and thereby, economic growth itself.

RBI’s role in tackling inflation

• The RBI’s explicit mandate is to conduct monetary policy. The primary objective of monetary policy is to maintain price stability while keeping in mind the objective of growth. Price stability is a necessary precondition to sustainable growth.
• In 2016, the Reserve Bank of India Act, 1934, was amended to provide a statutory basis for the implementation of a flexible inflation-targeting framework, where the Centre and the RBI would review and agree upon a specific inflation target every five years. 
• Under this, 4% was set as the Consumer Price Index (CPI) inflation target for the period from August 5, 2016, to March 31, 2021, with the upper tolerance limit of 6% and the lower tolerance limit of 2%. 
• To the extent that ensuring price stability is its primary goal, the RBI through its MPC must constantly assess not just current levels of inflation and prices of various goods and services in the economy, but also take into consideration inflation expectations both of consumers and financial markets so as to use an array of monetary tools, including interest rates, to contain inflation within its target range.

What is core inflation and why is it important?

• Core inflation helps measure inflation after excluding the effects of temporary volatility, especially from prices of items such as fuel and food. 
• For example, seasonal spikes in food prices may skew the inflation rate, but the effect is only transitory. 
• The RBI’s action on rates, however, affects the economy with a lag, by which time the spikes in the price of those food items may have reversed. Viewing inflation after stripping out such volatility helps give it a better picture of the underlying trend in prices. 

Related information

About MPC

• The Monetary Policy Committee is a committee of the RBI which is entrusted with the task of fixing the benchmark policy interest rate (repo rate) to contain inflation within the specified target level.
• The 2016 amendment of the Reserve Bank of India Act, 1934 provides for a statutory and institutionalised framework for the MPC.

• The MPC has six members
  • RBI Governor (Chairperson), RBI Deputy Governor in charge of monetary policy, one official nominated by the RBI Board and remaining 3 members would represent the Government. 

• The MPC makes decisions based on majority vote. In case of a tie, the RBI governor will have a second or casting vote. 

Repo Rate & Reverse Repo Rate

• Repo rate is the rate of interest which is applied by RBI to commercial banks when the latter borrows from RBI. Reverse Repo rate is the rate at which RBI borrows money from commercial banks by lending securities. 
• Both the Repo rate and Reverse Repo rate are used to control inflation and money supply in the economy.
• In the event of rising inflation, the RBI increases the repo rate which will act as a disincentive for banks to borrow from the central bank.
• This ultimately reduces the money supply in the economy and thus helps in arresting inflation. Similarly, if it wants to make it cheaper for banks to borrow money, it reduces the repo rate.

Monetary policy stance

• The Central Banks use different terms to indicate its monetary policy stance on deciding policy rates like repo rate.
• “Accommodative” indicates that the central bank is telling the market to expect a rate cut anytime, “neutral” means that RBI could either increase or reduce repo rates as per liquidity conditions, “calibrated tightening” means that a cut in the repo rate is unlikely in the current rate cycle.

Reference:

1. https://www.thehindu.com/business/Economy/rbi-keeps-key-rates-unchanged/article33246372.ece