Model Answer
0 min readIntroduction
The Reserve Bank of India (RBI) is entrusted with the crucial task of formulating and implementing monetary policy to achieve economic stability and growth. Over the last five years, the RBI’s monetary policy has been significantly shaped by both domestic and global economic developments, including the COVID-19 pandemic, geopolitical tensions, and inflationary pressures. The primary objective has been to maintain price stability while supporting economic growth, with a growing emphasis on financial stability. This has involved a dynamic approach, utilizing a range of conventional and unconventional tools to navigate a complex economic environment.
Main Objectives of Monetary Policy (2019-2024)
The RBI, operating under the framework of flexible inflation targeting (FIT), has primarily focused on the following objectives:
- Price Stability: Maintaining inflation within the target range of 4% ± 2%. This remains the primary objective, as stipulated by the government notification entrusting the RBI with FIT.
- Economic Growth: Supporting sustainable economic growth, particularly post-pandemic, by ensuring adequate liquidity and credit availability.
- Financial Stability: Preserving the stability of the financial system, mitigating systemic risks, and fostering confidence in the banking sector.
- Exchange Rate Management: Managing exchange rate volatility to promote external stability, though not as a direct target.
Steps to Encourage Investment
The RBI implemented several measures to stimulate investment during this period:
- Reduction in Policy Rates: The RBI significantly reduced the repo rate from 5.15% in February 2020 to a historic low of 4.0% during the pandemic (May 2020). This lowered the cost of borrowing for businesses.
- Liquidity Injection: The RBI injected substantial liquidity into the system through various measures, including Long-Term Repo Operations (LTROs) and Targeted Long-Term Repo Operations (TLTROs). TLTRO 2.0 (October 2020) specifically focused on providing liquidity to sectors most affected by the pandemic, like healthcare and tourism.
- Credit Guarantee Schemes: The RBI encouraged banks to extend credit to MSMEs through credit guarantee schemes, reducing the risk for lenders.
- Relaxation of Priority Sector Lending (PSL) norms: PSL norms were relaxed to encourage lending to sectors crucial for economic recovery.
- Infusion of Capital into Banks: Recapitalization of Public Sector Banks (PSBs) by the government, supported by the RBI’s efforts to improve asset quality, enhanced their lending capacity.
Steps to Maintain Price Stability
Despite the focus on growth, the RBI actively managed inflation:
- Liquidity Absorption: As inflation rose in 2022 and 2023, the RBI began absorbing liquidity through Variable Rate Reverse Repo (VRRR) auctions and standing deposit facility (SDF).
- Repo Rate Hikes: The RBI progressively increased the repo rate from 4.0% in May 2022 to 6.5% in February 2023, to curb demand-pull inflation.
- Inflation Forecasts and Forward Guidance: The RBI provided clear inflation forecasts and forward guidance to manage expectations and anchor inflation. The Monetary Policy Committee (MPC) regularly assessed inflation risks and adjusted policy accordingly.
- Managing Global Supply Chain Disruptions: The RBI monitored and responded to global supply chain disruptions that contributed to imported inflation.
- Strengthening Inflation Targeting Framework: Continued refinement of the FIT framework to enhance its effectiveness.
| Policy Tool | Objective | Implementation Period |
|---|---|---|
| Repo Rate Cuts | Boost Investment & Growth | 2020-2021 |
| TLTROs | Targeted Liquidity to Sectors | 2020-2021 |
| Repo Rate Hikes | Control Inflation | 2022-2023 |
| VRRR Auctions | Absorb Liquidity | 2022-2024 |
Conclusion
Over the past five years, the RBI has navigated a challenging economic landscape with a proactive and adaptable monetary policy. While prioritizing price stability under the FIT framework, it has also actively supported economic growth and financial stability through innovative liquidity management tools and targeted interventions. The recent focus on absorbing liquidity and raising interest rates reflects the RBI’s commitment to containing inflation, even at the cost of potentially moderating growth. The effectiveness of these policies will continue to be tested by evolving global and domestic conditions.
Answer Length
This is a comprehensive model answer for learning purposes and may exceed the word limit. In the exam, always adhere to the prescribed word count.