RBI raising rate

RBI raising rate

Subject: Economy

Section : Monetary Policy

Why in the news?

Former RBI governor Raghuram Rajan said that bureaucrats and politicians need to realise that raising policy rates does not amount to anti-national activity that benefits foreign investors  but is an investment in economic stability, whose greatest beneficiary is the Indian citizen.

Details:

RBI has shifted its focus to inflation as its first priority from growth. It will remain accommodative with a focus on the withdrawal of accommodation. Markets are anticipating a repo rate hike in the June policy.

Concept: 

Various types of monetary policy stances:

1. Accommodative-An accommodative stance means the central bank is prepared to expand the money supply to boost economic growth. The central bank, during an accommodative policy period, is willing to cut the interest rates. A rate hike is ruled out.

The Reserve Bank of India (RBI) has been on an accommodative stance for the last two years to support the economy during the COVID-19 crisis. The central bank typically adopts an accommodative policy when growth needs policy support and inflation is not the immediate concern.

1. Neutral-It suggests that the central bank can either cut rate or increase rate. This stance is typically adopted when the policy priority is equal to both inflation and growth. During neutral policy, the central bank doesn’t commit to hiking rates or cuts. The interest rate can move to either side depending on incoming data. The guidance indicates that the market can expect a rate action on either way at any point.
2. Hawkish-A hawkish stance indicates that the central bank’s top priority is to keep the inflation low. During such a phase, the central bank is willing to hike interest rates to curb money supply and thus reduce the demand. A hawkish policy also indicates tight monetary policy. A rate cut is nearly certain during such a period. When the central bank increases rates or ‘tightens’ the monetary policy, banks too increase their rate of interest on loans to end borrowers which, in turn, curbs demand in the financial system.
3. Calibrated tightening -Calibrated tightening means during the current rate cycle, a cut in the repo rate is off the table. But, the rate hike will happen in a calibrated manner. This means the central bank may not go for a rate increase in every policy meeting but the overall policy stance is tilted towards a rate hike. This can happen outside the policy meetings as well if the situation warrants.

Importance of rising rate of interest:

• Decline in credit growth-as borrowing becomes expensive.
• Decline in money supply and inflation– as credit  growth declines
• Capital inflows -as relative rate of return rises with respect to other countries.
• Currency appreciation– as supply of foreign currency rises relative to domestic currency
• Bond yield fall-Bond yields move in the opposite direction to their prices; since yields are closely correlated to the government policy rate, monetary tightening implies a bond rout, particularly when trillions of dollars’ worth of government bonds have been bid up to the point that they trade with negative yields.