The Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) opted to maintain the repo rate at 6.5% for the sixth consecutive time, signaling a commitment to a neutral stance and a gradual withdrawal of accommodation. This stance allows the RBI flexibility in managing liquidity, enabling adjustments to financial conditions by either tightening or loosening them. Currently, the focus is on reducing the accommodating conditions established during the COVID-19 crisis, aiming to curtail the amount of money in circulation.
During the pandemic, the RBI injected substantial liquidity into the banking system to stimulate economic activity by keeping borrowing costs low. However, starting in April 2022, the RBI shifted its approach to gradually withdraw this accommodation. Consequently, over the past six months, there has been a shortage of funds in the banking system, leading banks to borrow heavily from the RBI, reaching levels exceeding Rs 3 lakh crore in January.
Despite the RBI’s decision to maintain the repo rate, the effective interest rates in the market have risen. This shift is attributed to the RBI’s focus on reducing the availability of easy money, effectively tightening financial conditions akin to traditional rate hikes. The weighted average call rate (WACR), a key overnight market rate, has consistently exceeded the repo rate since April 2022, indicating tight liquidity in the financial system. This trend contrasts with previous rate hike periods, such as in June 2018, when the WACR was only higher than the repo rate once.
The February MPC meeting, held shortly after the budget announcement, was crucial in assessing how the RBI aligns its policies with the government’s fiscal objectives. Finance Minister Nirmala Sitharaman’s budget aimed to reduce the fiscal deficit target to below 4.5% of GDP by 2025-26, setting it at 5.1% for 2024-25. Despite increased spending in an election year, the government aims to narrow the budget shortfall, relying on optimistic tax revenue projections.
While retail inflation has decreased from its peak in July 2023, it remains relatively high, standing at 5.69% in December 2023, within the RBI’s comfort range of 4-6%. Governor Shaktikanta Das and his team have maintained a vigilant stance toward inflation, emphasizing the need for prudent monetary policy measures.
