Best Value For Your Money from RamaKrishnaVadlamudi: monetary policy framework

Showing posts with label monetary policy framework. Show all posts

Sunday, 15 August 2021

India CPI Inflation versus WPI Inflation - vrk100 - 15Aug2021

India CPI Inflation versus WPI Inflation

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Compare Consumer Price Index (CPI) and Wholesale Price Index (WPI):

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Read more: Fed Tapering is Postponed

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(please click on the chart for a better view)

Inflation numbers in India have been elevated for more than a year. In the last one year, CPI inflation registered a high of 7.6 per cent in October 2020, before cooling off to 5.6 per cent in July 2021.

Similar to CPI Inflation, WPI inflation too has been rising in recent months. It reached a peak of 12.9 per cent in June 2021, before falling slightly to 12.1 per cent last month.

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Indian savers and negative real interest rates 05Aug2021

Why worry about negative interest rates 14Jul2020

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As shown in the WPI inflation chart, manufacturers in India seemed to have attained some pricing power since the beginning of 2021. This pricing power is reflected in the steep rise in WPI in recent months. Sectors, like, metals and chemicals have gained pricing power which increased their profit pools hugely in recent quarters.

As described in the comparison chart above, there are slight differences between the weights (basket of goods and services) of CPI and WPI. CPI inflation numbers are more relevant to households and corporates. Prior to April 2014, India's central bank Reserve Bank of India (RBI) used WPI inflation as a nominal anchor for setting its monetary policy.

But from April 2014, RBI started using new CPI (combined) inflation as a key measure of its monetary policy. RBI adopted this inflation rate as the nominal anchor as part of the Urjit Patel Committee Report of January 2014.

CPI inflation closely reflects the cost of living for households. It also impacts inflationary expectations in the economy.

Even though RBI's monetary policy moved to Flexible Inflation Targeting (FIT) regime effective June 2016, RBI has failed to control inflationary expectations in India with the key measure of its monetary policy CPI inflation staying persistently above the upper bound (6 per cent) of its inflation target.

It may be mentioned that RBI signed an agreement called Monetary Policy Framework (MPF) with the Ministry of Finance, Government of India on February 20, 2015 whereby RBI was obligated to ensure that CPI inflation remained in the range of 2 to 6 per cent.

As the CPI inflation has been persistently above its outer range of 6 per cent (in 13 out of 20 months since December 2019), it is hoped that RBI will soon get a grip on the primary objective of its monetary policy, that is, anchoring inflationary expectations within the target range of 2 to 6 per cent.

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References:

Flexible Inflation Targeting - RBI report dated 25Nov2016

CPI inflation - Trading Economics

WPI inflation - TE

Disclosure: I've vested interested in Indian stocks and other investments. It's safe to assume I've interest in the financial products discussed, if any.

Disclaimer: The analysis and opinion provided here are only for information purposes and should not be construed as investment advice. Investors should consult their own financial advisers before making any investments. The author is a CFA Charterholder with a vested interest in financial markets.

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He blogs at:

https://ramakrishnavadlamudi.blogspot.com/

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Twitter @vrk100

Tuesday, 9 February 2021

Fiscal Deficit and Its Indirect Monetisation by Reserve Bank of India - vrk100 - 09Feb2021

Fiscal Deficit and Its Indirect Monetisation by Reserve Bank of India

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Indirect monetisation of fiscal deficit by Reserve Bank of India (RBI) has been heavy since 2008-09, with OMO (open market operations) purchases by RBI peaking at 63 per cent of net market borrowing in 2018-19 (not to speak of scheduled commercial banks' support to Government of India via mandatory SLR or statutory liquidity ratio)--leading to crowding out of the private sector.

Rising fiscal deficit has become a thorny issue for India since 2008-09, with OMO purchases supporting Government to an extent of 40 per cent of net market borrowings. In the past 13 years, only in 2014-15 and 2017-18, there were net OMO sales by RBI. The details of RBI's OMO purchases are provided in the table given below (click on it for expanded view):

With open market operations, RBI purchases and sells government securities and treasury bills. It is one of the main instruments of sterilisation used by the RBI. OMO sales entail the permanent absorption of the liquidity. Through OMO purchases, RBI injects liquidity into the banking system. RBI conducts open market operations regularly.

Open Market Operations (OMO) by RBI are supposed to be two ways. Committee after committee have spoken against outright monetisation of fiscal deficit via OMO purchases--eroding RBI's credibility in discretionary liquidity management.

Practically, Government of India's fiscal deficits are financed by RBI's one-sided OMO buying (see image) & support from commercial banks through mandatory SLR (statutory liquidity ratio). On top of that, banks hold excess SLR securities leading to market distortions.

With the introduction of FRBM (Fiscal Responsibility and Budget Management) Act in 2004, RBI cannot participate in the primary issuance of government bonds. But RBI is still resorting to government debt financing through outright OMO purchases in the secondary market.

No other major central bank uses OMO (one-sided) as blatantly as RBI in yield curve management, though OMOs are not to be used for that. Bond prices are the building blocks of asset pricing--with such distortions how can market players be sure of pricing of other assets?

RBI uses OMO to bring down long term yields by resorting to buying of government bonds, which is practically yield curve management, also known as yield curve control (YCC). Lower bond yields help governments in borrowing money from markets at cheaper rates.

With automatic monetisation via large OMO purchases, Reserve Bank of India has been printing money leading to debasement of money (lowering the purchasing power of currency).

In financial markets, government bond (called G-Secs in India for short) yields are the starting point for pricing of other assets. For example, corporate bonds are priced as a spread over G-Sec yields. G-Sec yields are also used for pricing equities and others.

With this indirect monetisation of fiscal deficits, RBI loses its credibility in conducting monetary policy objectively--reflecting poorly on central bank independence.

Side note: In financial market operations, open market operations are termed as open mouth operations.

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Please check my comments posted below >

Primer on Market Stabilisation Scheme and Liquidity Management 02Dec2016

What is LAF Repo Rate 23Jul2013

Bank Rate and its relevance 23Jul2013

What are cash management bills 15Jun2010

What is Marginal Standing Facility 20Jul2013

References:

My tweet thread dated 08Feb2021 on the above topic can be accessed at: weblink

Yield curve control (YCC): St Louis Fed blog dated 11Aug2020

Jan2014 Urjit Patel Report on Monetary Policy Framework (MPF)