Monetary Policy Framework of RBI : As Assessed by Bank of International Sattlement

DEC-2021

Reserve Bank of India

Institutional framework

The Reserve Bank of India Act, 1934, provides the legislative mandate to the Reserve Bank of India (RBI) to operate a modern monetary policy framework and, therefore, the RBI has adopted flexible inflation targeting (FIT) as the framework for monetary policy. The primary objective of monetary policy is to maintain price stability while keeping in mind the objective of growth. The Government of India, in consultation with RBI, sets the inflation target in terms of the Consumer Price Index (CPI) every five years (current target applicable from April 2021 to March 2026).

To achieve the objectives of monetary policy, the RBI uses an interest rate framework with the overnight call money market rate, measured by the weighted average call money rate (WACR), as the operating target. A Monetary Policy Committee (MPC), with the Governor of the RBI as its chairperson, determines the policy rate, i.e., the repo rate, required to achieve the mandated inflation target. The RBI endeavours to anchor the operating target, i.e., WACR, to the policy repo rate through the instruments available under monetary policy implementation framework.

A semi-annual Monetary Policy Report (MPR) is issued by the RBI, elucidating the macroeconomic framework, analysis of developments along with forecasts of inflation and output, liquidity conditions and financial market developments along with global environment and outlook.

Key features of the monetary policy implementation framework

The monetary policy framework aims at setting the policy repo rate at an appropriate level to achieve the monetary policy objectives based on an assessment of the current and evolving macroeconomic situation. Liquidity management is the operating procedure of monetary policy which envisages modulation of liquidity conditions, aimed at anchoring the WACR to the policy repo rate. Within its implementation framework, the RBI undertakes repurchase operations under Liquidity Adjustment Facility (LAF) and Open Market Operations involving outright sale and purchase of eligible securities, offers standing facilities and requires banks to hold minimum reserves in their current accounts with it. The current minimum reserve requirement has been set at 4 per cent of the net demand and time liabilities (NDTL) of banks and the reserves are held in the form of Cash Reserve Ratio (CRR) by banks in their current account with the RBI. These reserves are not remunerated. RBI allows limited averaging of reserves within the maintenance period, i.e., a fortnight, to allow banks to absorb liquidity shocks at their discretion and to help in stabilising short-term interest rates in the money markets.

Reverse-repo is a standing facility for deposit of funds by the eligible entities with the RBI. In addition, the RBI has provided standing lending facility viz., Marginal Standing Facility (MSF), which eligible entities can access to meet their overnight reserve requirements arising out of unforeseen frictional factors. The liquidity management corridor has the MSF rate as its upper bound (ceiling), currently 25 bps above the repo-rate and the fixed rate reverse repo rate as the lower bound (floor), which is 65 bps below the repo rate with the policy repo rate, which is set by MPC, in between. Thus, the MSF together with the fixed rate reverse repo rate constitute the corridor for overnight money market rates. To further strengthen the operating framework, an uncollateralised Standing Deposit Facility (SDF) has been notified but this is yet to be operationalised.

The Reserve Bank introduced the revised liquidity management framework in February 2020. As part of this framework, the RBI conducts a 14-day variable-rate term repo/ reverse repo as the main liquidity operation to coincide with the CRR maintenance cycle for managing frictional liquidity requirements. The main liquidity operation is supported by fine-tuning operations, overnight and/or of longer duration, to tide over any unanticipated liquidity changes during the reserve maintenance period. In addition, the Reserve Bank can conduct, if needed, longer-term variable rate repo/reverse repo operations of more than 14 days. Outright Open Market Operations (OMOs) and long-term FX swap auctions are conducted for supplying/withdrawing liquidity for longer duration to steer liquidity conditions consistent with the monetary policy objective. All the liquidity management operations of the RBI are collateralised by eligible collateral notified by the RBI from time to time.