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RBI needs to watch out for threats to financial stability

The unsurprising aspect of the Reserve Bank of India’s Monetary Policy Committee meeting was the decision to keep the policy rate, or repo, unchanged at 4%. The MPC also said the current accommodative liquidity policy will continue to help revive growth.

The most significant change in the MPC’s statement is the increase in its inflation projections. Now, it is forecast to be 5.7% for 2021-22. Just three months ago, it was forecast to be 4.9%. The MPC believes the rise in the general level of prices is transitory, caused by supply disruptions on account of the pandemic. The MPC also retained its GDP forecast for 2021-22 at 9.5%.

Read also: RBI keeps rates on hold, retains GDP growth target at 9.5% for 2021-22

The additional risk emerges from the fact that bank deposits, the favourite financial asset of Indian households, are likely to provide negative returns across almost all maturities. The MPC is also unlikely to increase the repo as boosting economic growth is the priority. This is the context in which financial instability can arise as households may underestimate risks in the search for yields that are higher than what bank deposits offer. The central bank needs to be alive to this possibility.

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