Covid-19 & Monetary Policy’s Credibility

What is the issue?

• Many unconventional measures are being taken to tackle the impact of ongoing Covid-led lockdown on the economy.
• However, these measures are to be taken without undermining the institutional frameworks.

What are the projections?

• Many economists are expecting the Indian economy to contract in the current fiscal year.
• These projections may worsen as it is still not clear when normalcy would be restored.

What are the measures taken?

• The Indian government has announced only a Rs 1.7-trillion package for the most vulnerable section of the population.
• The Reserve Bank of India (RBI) is doing the most of the heavy lifting.
• The RBI has reduced interest rates.
• It reduced the reverse repo rate outside the Monetary Policy Committee (MPC) cycle.
• The RBI has flooded the banking system with liquidity.
• Currently, the system has an excess liquidity worth about Rs.7 trillion.
• Some of the recent policy decisions of the RBI may end up creating longer-term risks.

Did increasing the liquidity help?

• The excess liquidity has not eased pressure in the financial system to the extent desired.
• Even when the MPC decided to keep the policy rate unchanged, the RBI increased liquidity in the system.
• Liquidity was increased to influence medium-term market rates.
• If the market rates are to be brought down, it should be through building a consensus in the MPC to cut policy rates with proper explanation.

What is the current situation?

• With so much liquidity in the system, market rates are now controlled by the RBI and not by the MPC.
• Undermining the MPC can increase financial stability risks, especially in uncertain times.

What could be done?

• In the given economic environment, the policymakers would need to take some extraordinary and unconventional measures.
• But it will also be critical to protect the credibility of institutions.
• If the markets believe that institutional structures and checks are not being undermined, the financial stability could be maintained.

Source: Business Standard

Quick Facts

Monetary Policy Committee (MPC)

• The Finance Act, 2016 amended the RBI Act, 1934 to provide for a statutory framework for a Monetary Policy Committee.
• The MPC will maintain price stability, while keeping in mind the objective of growth.
• It would fix the benchmark policy rate (repo rate) required to contain inflation within the specified target level.
• As per the provisions of the RBI Act, out of the six members of MPC,
  1. Three Members will be from the RBI and
  2. Three members will be appointed by the Central Government.
• The meetings of the MPC shall be held at least 4 times a year and it shall publish its decisions after each such meeting.