Strengthening India's Economic Resilience: A Review of Monetary Policy : Daily News Analysis

Date : 11/08/2023

Relevance: GS Paper 3 - Monetary Policy

Keywords: Monetary policy, economic resilience, global macroeconomic trends, inflation projection, growth outlook, digital initiatives, financial inclusivity

Context-

In a dynamic financial landscape, central banks can often achieve their goals not by altering their objectives, but by adopting novel approaches. The recent monetary policy decision, unveiled on Thursday, underscores this principle. By upholding established policies, this decision fortifies the foundation of India's economy, positioning it to navigate potential external shocks with resilience and adaptability.

Monetary Policy

Monetary policy refers to a macroeconomic strategy established by a country's central bank to achieve specific goals such as managing inflation, promoting consumption, fostering economic growth, and ensuring liquidity. It operates as a demand-side economic approach employed by the government to influence the overall economic conditions.
Monetary policy encompasses various tools, both direct and indirect, aimed at altering interest rates. These tools include open market operations, reserve requirements, and foreign exchange trading. A subset of monetary policy is credit policy, which governs the extent and interest rates at which banks provide credit.

There are two primary categories of monetary policy: expansionary and contractionary policies.

Expansionary policy: This approach is employed to stimulate economic activity during periods of slowdown or recession. It involves increasing the overall money supply within the economy. Accomplished by reducing general interest rates on loans and debt instruments, lower interest rates encourage higher consumer spending and borrowing. This, in turn, promotes economic growth and recovery.
Contractionary policy: Implemented through an increase in interest rates, the contractionary policy aims to decrease the total money supply in the economy. By raising interest rates, this policy seeks to counteract inflationary pressures caused by an excessive money supply, thereby stabilizing prices.

Monetary policy is a vital tool for governments and central banks to achieve economic objectives. It aims to ensure price stability, drive economic growth, stabilize exchange rates, balance savings and investment, generate employment, and maintain financial stability. In India, the Reserve Bank collaborates with the government to set flexible inflation targets, adapting to changing economic conditions.

Navigating Uncertain Global Macroeconomic Trends

The global economic scenario remains uncertain, marked by central banks in advanced economies raising rates amid persistent inflationary pressures and intricate signals from labor markets. This intricate environment has led to complex repercussions, including the waning advantage of arbitrage across jurisdictions.
A recent downgrade of the US by Fitch Ratings and tech-related tensions between the US and China further contribute to the global economic intricacy. China's faltering export and import figures, along with significant defaults in its property market, compound these challenges.

Retaining Policy Rates: A Prudent Move

Amidst these international complexities, the Reserve Bank of India (RBI) has chosen to maintain its policy rates and unchanged stance. The RBI has adjusted its inflation projection for 2023-24 to 5.4%, while a notable upward revision in second-quarter estimates to 6.2% - attributed to a surge in vegetable prices, particularly tomatoes - warrants attention. Despite this, it is anticipated that the inflationary impact will be transient and subside as fresh vegetable supplies replenish.
Following the recent surge in inflation beyond 6.5%, a subsequent decline is projected from September, gradually converging towards 6% or lower. The anticipated decrease in core inflation to around 5% brings added reassurance, aligning with empirical evidence that suggests headline inflation tends to revert to core inflation in India.

Innovative Measures and Growth Outlook

The surprise introduction of an incremental cash reserve ratio of 10% on the increase in net demand and time liabilities (NDTL) from May 19 to July 28 aimed at absorbing excess liquidity is noteworthy. This move is likely to withdraw approximately Rs 1 trillion from the banking system and effectively manage liquidity, particularly considering the influx of Rs 2,000 notes into deposits. Consequently, this measure could play a pivotal role in stabilizing inflation and inflationary expectations.
The outlook for growth remains balanced, with prospects of exceeding the RBI's projected 6.5%. A robust banking ecosystem, coupled with moderating core inflation despite volatility in vegetable and grocery prices, fosters optimism and rejuvenates credit demand. Regulatory policies, as evidenced by the comprehensive framework for financial benchmarks and revisions in NBFC- IDF regulations, reflect a commitment to transparency, governance, and sustainable growth.

Augmenting Payment Systems and Digital Initiatives

RBI's initiatives extend to payment systems, including innovative modes such as "Conversational Payments" on UPI, enhancing ease of use and security. Offline transaction capabilities through UPI-Lite utilizing near-field communication (NFC) technology bolster the adoption of UPI for small-value transactions.
The elevation of the lower limit for small-value offline digital payments to Rs 500, along with the proposition of a Digital Public Tech Platform based on the successful KCC pilot, underpins financial inclusivity and prudent credit distribution.

Conclusion: A Robust Framework for Economic Vigilance

The recent monetary policy reaffirms the RBI's commitment to maintaining stability, promoting sustainable growth, and enhancing the resilience of India's economy against global volatility. The convergence of traditional policies with innovative measures, bolstered by pragmatic regulatory changes, creates a comprehensive framework that not only mitigates risks but also propels the nation toward a path of balanced and steadfast economic progress.

Probable Questions for UPSC Main Exam-

In the context of the evolving global economic landscape, how does the Reserve Bank of India's monetary policy decision contribute to fortifying India's economic resilience and adaptability against external shocks? (10 Marks, 150 Words)
How do the proposed initiatives, such as "Conversational Payments" and the Digital Public Tech Platform, reflect the Reserve Bank of India's commitment to promoting financial inclusivity and innovation in the digital payment ecosystem? (15 Marks, 250 Words)

Source- The Indian Express