Central Idea

• In its last meeting, held just a few days after the Union budget, the monetary policy committee (MPC) of the RBI had voted to raise the benchmark repo rate by 25 basis points. The MPC noted that calibrated action was warranted to break the persistence in core inflation. This surprise uptick in inflation is likely to complicate the policy choices before the MPC members when it meets next in the first week of April.

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What is Basis points we often hear about?

• A basis point is a unit of measurement used to express changes in interest rates, bond yields, and other financial indicators.
• One basis point is equal to one-hundredth of a percentage point, or 0.01%.
• For example, If the Reserve Bank of India (RBI) raises the repo rate by 25 basis points, it means that the interest rate has increased by 0.25%.

What it indicates?

• If the Reserve Bank of India (RBI) keeps raising the repo rate by basis points, it is an indication that the central bank is tightening its monetary policy stance to manage inflationary pressures in the economy.

Back to basics: Monetary Policy Committee (MPC)

• Committee of RBI to fix the benchmark policy: The Monetary Policy Committee (MPC) 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.
• To bring transparency and accountability: The RBI Act, 1934 was amended by Finance Act (India), 2016 to constitute MPC to bring more transparency and accountability in fixing India’s Monetary Policy.
• Policy is published after discussion: The policy is published after every meeting with each member explaining his opinions.
• Answerable to GOI: The committee is answerable to the Government of India if the inflation exceeds the range prescribed for three consecutive months.

What is Inflation?

• Inflation is an increase in the level of prices of the goods and services that households buy. It is measured as the rate of change of those prices.
• Typically, prices rise over time, but prices can also fall (a situation called deflation).

The current trends of Inflation

• Rise in retail inflation: Retail inflation, as measured by the consumer price index, rose to 6.52 per cent in January, up from 5.72 per cent in December, reversing the declining trend seen in the preceding months.
• Much of the surge was driven by food inflation: The consumer food price index rose to 5.94 per cent, up from 4.19 the month before, driven largely by cereals.
• Price pressure remain across the economy: Inflation remained elevated in clothing and footwear, household goods and services, personal care effects and education, signalling that price pressures remain fairly broad-based across the economy.

RBI’s Upper tolerance limit for inflation

• Highest level of inflation that can be tolerated: The upper tolerance limit for inflation set by the Reserve Bank of India (RBI) is the highest level of inflation that the RBI will tolerate before taking action to bring inflation back within its target range.
• RBI’s limit: The target range is defined in terms of the Consumer Price Index (CPI) inflation and the RBI has set an upper tolerance limit of 6% and a lower tolerance limit of 2% with a central target of 4%. This means that the RBI aims to keep CPI inflation within the range of 2-6%, with a target of 4%.
• Tools to contain inflation: If inflation exceeds the upper tolerance limit of 6%, the RBI is required to take steps to bring inflation back within the target range. The RBI uses a variety of monetary policy tools to control inflation, including adjusting the policy interest rate, changing reserve requirements for banks, and using open market operations to manage liquidity in the financial system.

Conclusion

• Monetary policy experts Varma and Goyal suggest pausing to observe the impact of previous tightening before taking further action. Despite a cumulative 250 basis point increase, inflation is still expected to remain above the 6% target. The full impact of previous tightening should be considered before making any decisions.

Mains Question

Q. What is upper threshold of the RBI’s inflation targeting framework? Discuss the impact of policy interest rate hikes on the economy.

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