The article analyses the implications of the recently concluded MPC meeting and predicts the trends for the future.

Highlights of the MPC meeting

• In the October meeting of the monetary policy committee (MPC), repo rate were kept unchanged at 4%, with a continuation of an accommodative stance.
• It chose to ignore elevated levels of CPI inflation as transitory and maintaining focus on supporting growth.
• It appears that the MPC would maintain a status quo on rates through this fiscal year.
• The scope for further easing is anyways limited to 0.50%, as any more easing may affect household financial savings and endanger financial stability.

Ensuring the rate transmission

• With unchanged repo rates, the focus of the liquidity measures announced by the RBI is to further improve transmission of previous rate cuts across a spectrum of market rates and other instruments.
• The RBI Governor assured market participants that the large supply of government bonds in the second half along with a likely pick-up in credit demand, would be accommodated through open market purchases of government bonds.

Reducing the cost of borrowing

• The RBI may have to buy bonds worth ₹1,000 to 1,500 billion in these operations over 2HFY21 keeping pressure on yields [which affects interest rates].
• In a related move, to reduce the cost of borrowings for state governments, the RBI for the first time will buy state government bonds, as a special case for this year.

Other measures

• The extension of enhanced Held to Maturity (HTM) limit of banks on their government bonds portfolio to March 2022.
• A new on-tap targeted LTRO window was announced, for banks to borrow up to ₹1,000 billion from the RBI at a floating rate linked to the repo rate, and invest in corporate paper issued by specific sectors and to provide loans to them.
• In effect, the aim of the central bank is to ensure that lower policy rates determined by the macro-economic fundamentals, are reflected in lower cost of borrowings for the Centre, states and corporates.

Containing inflation

• Inflation outlook for this fiscal and projections for next year indicate that CPI inflation would ease, from an average of 6.8% in Q2 to 4.5% in Q4 and 4.1% by Q4FY22.
• Headline inflation is expected to fall, as supply conditions normalize with progressive unlocking and another year of bumper farm output helps pull down food inflation.
• Higher fuel taxes and import duties are expected to provide an upward push though.
• Effective supply management will therefore be crucial in controlling food inflation and ensuring that it does not turn persistent and feeds into non-food inflation.

Conclusion

• The role of monetary policy in the is limited and the RBI focus will remain on improving transmission of policy signals through banking, bond and credit market channels.

Back2Basics: LTRO

• Long-Term Repo Operation (LTRO) was introduced by the Reserve Bank in February, 2020.
• Through this policy, the central bank would provide liquidity support to commercial banks for a period of 1 to 3 years at the current repo rate, and would accept government securities as collateral in return.
• This is in contrast to the other measures it was providing such as Liquidity Adjustment Facility (LAF) and Marginal Standing Facility (MSF) which provide cash to banks for a period of 1 to 28 days only.

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