4th Monetary Policy Statement Released

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On the basis of an assessment of the current and evolving macroeconomic situation at its meeting, the Monetary Policy Committee (MPC) decided to:

– Reduce the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis points from 6.5 per cent to 6.25 per cent with immediate effect.

– Consequently, the reverse repo rate under the LAF stands adjusted to 5.75 per cent, and the marginal standing facility (MSF) rate and the Bank Rate to 6.75 per cent.

Reasons:

The decision of the MPC is consistent with an accommodative stance of monetary policy in consonance with the objective of achieving consumer price index (CPI) inflation at 5 per cent by Q4 of 2016-17 and the medium-term target of 4 per cent within a band of +/- 2 per cent, while supporting growth.

Assessment of MPC:

1. Global growth has been slowing more than anticipated through 2016 so far, with weak investment and trade damping aggregate demand. Meanwhile, risks in the form of Brexit, banking stress in Europe, rebalancing of debt-fuelled growth in China, rising protectionism and diminishing confidence in monetary policy have slanted the outlook to the downside. World trade volume has contracted sharper than expected in the first half of 2016, and the outlook has worsened with the recent falling off of imports by advanced economies (AEs) from emerging market economies (EMEs). Inflation remains subdued in AEs and has started to edge down in EMEs.

2. International financial markets were overwhelmed by the Brexit vote in Q2, with equity markets losing valuations worldwide, currencies plunging and turning volatile, and investors rushing for safe havens. Markets, however, recovered quickly and reclaimed lost ground in Q3, with a return of risk appetite propelling capital flows back into EMEs. Nonetheless, an uneasy calm prevails on uncertainty about the stance of monetary policy of systemic central banks. Commodity prices have firmed up slightly, easing stress for commodity exporters and shaving off some of the terms of trade gains accruing to commodity importers. Crude prices rose to a recent peak in Q2 of 2016, mostly on supply disruption in various parts of the world, and again in late September as the OPEC announced intentions of cutting back on supply; but, the upturn has been curbed by higher inventories.

3. On the domestic front, the outlook for agricultural activity has brightened considerably. The south west monsoon ended the season with a cumulative deficit of only 3 per cent below the long period average, with 85 per cent of the country’s geographical area having received normal to excess precipitation. Kharif sowing has surpassed last year’s acreage, barring cotton, sugarcane and jute and mesta.

4. Retail inflation measured by the headline CPI had been elevated by a sharp pick-up in the momentum of food inflation overwhelming favourable base effects during April-July. In August, however, the momentum of food inflation turned negative and surprised expectations; consequently, base effects in that month came into full play and pulled down headline inflation to an intra-year low.

5. Liquidity conditions have remained comfortable in Q3, with the Reserve Bank absorbing liquidity on a net basis through variable rate reverse repo auctions of varying tenors. Liquidity was injected through open market purchases of ₹200 billion in line with the system’s requirements. As a result, the weighted average call money rate (WACR) remained tightly aligned with the policy repo rate and, in fact, traded with a soft bias. Interest rates on commercial paper (CPs) and certificates of deposit (CD) also eased.

6. In the external sector, merchandise exports contracted in the first two months of Q2. Subdued domestic demand was, however, reflected in a faster contraction in imports. Moreover, the still soft crude prices pared off a fifth of the oil import bill and gold import volume slumped to a fifth of its volume a year ago. Consequently, the merchandise trade deficit narrowed by US$ 10 billion in April-August on a year-on-year basis.

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