Policy Prudence

Context: With the rising uncertainties in the economy worldwide due to the pandemic, the Reserve Bank of India (RBI) should guard against risks to financial stability.

Continuing economic issues

• High Inflation: Inflation based on the consumer price index continues to remain above the target band of the central bank.

• Low-Income generation: due to the shutdown and limited opening of the economy have affected incomes for a large number of individuals.
• Supply chain disruptions: due to localized lockdowns in several states. 

Steps taken by the RBI

• Cutting policy rates: Reduced Cash Reserve Ratio and Repo Rate.
• Infusion of liquidity in the system: through interventions such as long-term repo operations, termed long-term repo operations and regular open market operations.
• Interventions in the foreign currency market: to avoid appreciation in the rupee which has resulted in swelling of RBI’s balance sheet to 27% of gross domestic product.

Challenges for the RBI:

• Large Surplus of foreign exchange: 
• It cannot stop intervening in the market as this would result in rupee appreciation and affect trade competitiveness.
• Continued intervention would add to rupee liquidity and can potentially become a risk for both price and financial stability.
• Inflated Equity Markets: has pushed up valuations which would restrict the possibility of the RBI intervening in the bond market to smoothen the yield curve.

Way Forward: The central bank needs to be vigilant and avoid risks to price and financial stability.