Monetary policy in India underwent a regime change during 2016-17. The amendments to the Reserve Bank of India (RBI) Act, which came into force on June 27, 2016, provided it the legislative mandate to operate the monetary policy framework with its objective explicitly defined as ‘to maintain price stability while keeping in mind the objective of growth.’
On August 5, 2016, the Government notified the inflation target as 4 per cent year-on-year growth in CPI-combined inflation with upper and lower tolerance levels of 6 and 2 per cent, respectively. The amended RBI Act also provides for the formation of a six-member Monetary Policy Committee (MPC) entrusted with the decision on setting the policy rate. In turn, the Reserve Bank was enjoined to set out the operating framework in the public domain explaining implementation of the MPC’s decision. The Reserve Bank’s monetary policy statement laid out the operating framework of the monetary policy and the adjustments thereto have been reported in subsequent policy statements/monetary policy reports (MPRs).
The operating framework aims at modulating liquidity conditions so as to ensure that the operating target – the weighted average call money rate (WACR) – evolves in close alignment with the policy rate.
Liquidity operations were recalibrated under a revised framework announced in April 2016 which, inter alia, included smoothening liquidity supply through timely use of open market purchase/sale auctions in conjunction with normal liquidity facilities and fine-tuning operations. The objective was to progressively balance liquidity in the system to a position closer to neutrality. As a result, the net position under the liquidity adjustment facility (LAF) switched from an average daily liquidity injection (or system level deficit) of Rs 813 billion during Q1: 2016-17 to an average daily absorption (or system level surplus) of Rs 63 billion in October 2016. In the process, scheduled redemptions of FCNR (B) deposits during September-November 2016 were managed without any perturbations in market liquidity.
