The Reserve Bank of India which is the Central Bank of India formulates the monetary policy which states measures taken to regulate the availability and supply of money, and the cost of credit in the economy. The policy also states the borrowing and lending rates of interests.

The primary objective of the monetary policy is to maintain price stability while ensuring the growth of the country.

The six members of the monetary policy committee headed by the governor of India meet 4 times a year to set the repo rate based on the assessment of the current and evolving macroeconomic situation such as employment, inflation, productivity, interest rates, and the foreign trade deficit. Once every 6 months, the RBI publishes a Monetary Policy report.

On February 10, 2022, the RBI announced its monetary policy and in this article, we will understand what the policy decisions mean. But before we get into further details on the decisions taken at the latest meeting, let us understand the difference between the two types of policies that are in place in the context of the economy.

A) Fiscal Policy

B) Monetary Policy

Monetary policy and fiscal policy are two different tools that have an impact on the economic activity of a country.

Now that we know the major differences between the two policies, let us take a look at the monetary instruments that the Central Bank uses to maintain a very low rate of inflation or deflation so that the general level of prices do not have major changes.

RBI KEEPS REPO RATE UNCHANGED, SEES INFLATION AT 4.5% IN FY23

Before we understand what this means for the bond market, it is important to know that Interest rates have a parallel relationship with bond yields, whereas bond yields have an inverse relation with the price of bonds.

The bond market this time had anticipated changes in the parameters which would increase the interest rate, therefore hoping that the changes would bring down the price of bonds. But now with the MPC keeping the parameters unchanged and the demand still staying the same in the bond market, prices of such bonds rose and the interest rates moved down.

The RBI had said that in order to support the economy after the disastrous effects of Covid-19, they have decided to maintain the ‘accommodative stance’ to revive and sustain the growth in the economy.

Now, what does RBI mean by an accommodative stance? It means the central bank wants to keep the rates of the monetary instruments that we had talked about earlier unchanged. The decision by the government shows that RBI is willing to infuse more money into the economy to boost the country’s economic growth until the inflation is under the set target.

By doing this it means that lending rates would be low that way corporations and MSMEs would be able to make more loans at a low-interest rate from banks which would fuel more growth for the country.

Another key factor to track at the RBI meeting is the MPC’s projection of the Consumer Price Index (CPI) inflation rate. Now, what is CPI? It is the index that measures the retail inflation in the economy by collecting changes in the price of most common goods and services.

The RBI in its latest meeting said that as it expects a normal monsoon in 2022, it has projected Consumer Price Index (CPI) inflation of 4.5% in 2022-23 (Q1- 4.9%, Q2- 5%, Q3- 4%, and Q4- 4.2%).

These decisions align to achieve the medium-term target for consumer price index (CPI) inflation of 4 percent within a band of +/- 2 percent while supporting growth.

What does the RBI mean by a normal monsoon? A normal monsoon means the country will receive a sufficient amount of rainfall which would, in turn, help farmers and their incomes rise. Now if farmers' incomes rise, it means there will be a good supply of food and commodities which in turn will allow prices of goods and services to stay affordable, thereby maintaining rural demand and consumption.

If monsoons are not good this year, it would mean a lack of supply and more demand which would lead to prices of goods and commodities rising up.

Rising Crude oil prices a concern?

The RBI has taken into consideration the situation with Ukraine and Russia and has said action will be taken if oil prices rise.

“Uncertainties about energy prices have risen considerably. Indian crude oil basket is up nearly 25% in the previous two months. The current geopolitical stress in Europe is a significant risk and if it translates into oil and gas prices spiking, we will need to adjust macro-economic policies suitably,” the MPC committee said in the meeting.

Now, rising crude oil prices are detrimental for the bond market as it would mean import prices would rise and that in turn will increase inflation. If inflation rises, the fiscal deficit which is the difference between total revenue and total expenditure of the government will also rise. Henceforth, to fill up the gap created by the Fiscal deficit, more borrowings would be required.

If the Fiscal deficit is more, the govt will issue more bonds, which means more supply of bonds in the market which would bring down the price of existing bonds in the market. Now, as yields and price of bonds have an inverse relationship, the Yields of the already existing bonds will increase. If the already existing bonds have a high yield, the new bonds will have a higher coupon rate to match the high yields in the market.