Understanding the RBI’s Monetary Policy 2021-22

Yesterday, the RBI came up with its Monetary Policy for FY22. And we know it isn't exactly digestible for most. So, we're here with a simplified explanation of the policy.

For neophytes, the RBI is entrusted with the monetary policy of the economy. It's like we've told it -- "Dear RBI, you're the supremo of India's financial and economic environment. You and your boys have got to ensure that we witness optimal growth. But hey, that doesn't mean prices should touch the sky, No. You have to see that too. And all of this, not at the cost of a volatile rupee. Also, please look after our banks. Be our superhero in times of need. We don't know how you'll do all of this, but we trust you. It's on you, sorry!"

And for the most part, well, it does, you could say. This time too, after days of brainstorming discussions, its Monetary Policy Committee (MPC) has come up with an encouraging policy and report. Well, read on this piece, and we assure you'll nail the dinner table discussion tonight.

At the outset, let's visualize the present state of the economy through the RBI's lenses.

The RBI's view of prevailing economic conditions

Unlike the last year, the RBI is really optimistic about the upcoming days. It expects the growth to be more robust this year. Although the rural demand brought some respite to the economy, the RBI feels urban demand will largely depend upon the vaccination drive. In addition to this, investment measures taken by the government are expected to boost up the economy. As the RBI governor said, and we quote -- "juxtaposition of high-frequency lead and co-incident indicators" probably tell that winter is gone and it's time for spring.

However, it's not exactly all rosy. Food prices haven't cooled down yet due to rising international prices and logistics costs. The volatility in commodity prices in the international market will be another thing to watch out for. And above all, the recent surge in cases of subsequent waves of the coronavirus might recreate a grim outlook for the economy! Another nationwide lockdown could totally disrupt the economy, which was just taking its baby steps towards recovery!

And now you know why the RBI has retained its GDP growth projection at 10.5% for FY22.

Okay, without further ado, let's understand what all gifts the RBI's monetary policy toolkit has to offer this time.

Growth vs Inflation dilemma

So, if you read the news or somehow watched the RBI governor revealing the monetary policy, you must have heard this, that this time, the RBI has maintained its "accommodative stance". And you probably didn't bother to find out what that really means! Well, basically, it means that the RBI still wants to persuade people to go out and spend. And how does it do that, you ask? Well, by keeping the interest rates low. Okay, but how?

Well, the RBI has kept the Repo and Reverse Repo rates unchanged at 4% and 3.35%, respectively. Not complicating much, these are the rates at which banks borrow and lend to the RBI, respectively. And if these rates are low, the bank interest rates will be low, simple. Further, if the bank interest rates are low, people will borrow more and deposit less. So, they might spend more. And consumer spending is crucial for economic growth as it's the largest part of the GDP. So now you know why the RBI has maintained this 'accommodative stance'.

However, there is an inherent problem in this approach. If people are ready to spend more, the consumer demand will rise, which in turn will lead to an increase in prices, i.e. inflation. And that brings the RBI to a catch-22 situation! Whether to boost economic growth or control inflation, a real dilemma indeed!

Anyway, the RBI seems to have already accounted for these issues. And expects that inflation for the year will be around 5%, well within the target range of 2-6%. And better so!

So, in a way, you could say, this monetary policy has followed a much-needed growth-centric approach.

What's more, is that the RBI has also decided to revamp its (criticized) inflation forecasting model to fine-tune its predictions. So, make of it what you will.

Liquidity injection

Seems the RBI has left no stones unturned in ensuring ample liquidity in the economy. As we explained, people having money spurs spending, which in turn boosts economic growth.

If there is something that's gonna make headlines in this monetary policy news, is the "GSAP 1.0". A typical Bollywood movie title, indeed. Well, this is basically, 'a secondary market G-sec acquisition program'. To understand this, let's have a look at the government bonds' scene.

You see, when the government wants to boost its spendings, it borrows, sometimes from other countries and sometimes from within, by issuing bonds, called G-secs. This year, in order to spur its spendings, the government had done the same. Now in order to entice investors to invest in these bonds, it had upped the interest rates. But know this thing that when the interest rates increase, borrowing becomes costly. And that is why bond traders were unhappy about the increasing yields.

Now, the RBI is planning to purchase these G-secs from the secondary market, which will help in keeping the yield normal (promote borrowings) and also inject liquidity into the system. And that's what makes GSAP 1.0 a real blessing for the markets.

It plans to make such open market purchases of G-secs to the tune of Rs 1 Lakhs Crores in Q1 FY22. And just so you know, this is the first time that the RBI is itself paying to keep the borrowing markets stable. So, kudos to the team.

However, for bond investors, it's apt to get in early before the prices rise and yields turn south.

The complimentary gifts

So, these additional measures are beyond the remit of the Monetary Policy Committee. Anyway, there is some real good stuff here as well.

The first gift is the extension of the 'On Tap TLTRO' scheme by 6 months till September 30, 2021. Well, under this scheme, the RBI provides funds to distressed sectors like construction, real estate and microfinance, at a floating rate linked to the repo rate.

The RBI will also provide special re-finance facilities of Rs. 50,000 Crores to NABARD, SIDBI and NHB. This will boost up lending to MSMEs, housing and agriculture sectors.

It has also proposed to set up a committee to review and assist the Asset Reconstruction Companies (ARCs), which help the stressed banks get bad loans off their books.

However, what we feel could be a really praise-worthy offering from this toolkit is its initiative towards financial inclusion. In a bid to promote digitalization of transactions, the RBI has extended the RTGS and NEFT facilities (which was earlier confined to banks) to other payment operators like cards, digital wallets, etc. This means you can actually send money from one company's wallet to another and from your wallet to bank account as well. Moreover, you can use digital wallets to withdraw money at ATMs or to make payments at POS terminals. This will indeed go a long way in minimizing settlement failures, securing transactions and ultimately, ensuring financial inclusion. Isn't it?

Moreover, the current daily balance limit in payment banks, i.e. Rs. 1 Lakh per customer, has been increased to Rs. 2 Lakh, which is another great move in making the financial system more embracing. So, brownie points for that as well.

The Bottom Line

While there are criticisms about this monetary policy, the domestic markets seem to have taken it quite well. Bond yields fell. Both Sensex and Nifty ended up higher post the monetary policy announcements. If you ask us, we feel this kind of expansionary policy is all that we need from the RBI today. And perhaps our superhero has struck a note.

Anyway, what are your views? Let us know in the comments below.

Amidst these fighting times, we would like to end this piece with these apt words from Martin Luther King, that the RBI governor had quoted and we requote --

"We must accept finite disappointment but never lose infinite hope."

*touchwood