RBI Hikes Repo Rate

Why in the News?

The Monetary Policy Committee of the Reserve Bank of India has increased repo rates by 50 basis points to 5.4 per cent.

Key Points:

About Monetary Policy Committee 

• Urjit Patel committee in 2014 recommended the establishment of the Monetary Policy Committee.
  • The first MPC was constituted on September 29, 2016.
• The Central government is empowered to constitute a six-member Monetary Policy Committee (MPC) Under Section 45ZB of the amended RBI Act, 1934.
• The decision of the Monetary Policy Committee shall be binding on the RBI.

• Mandate of MPC:

• • The Monetary Policy Committee shall determine the Policy Rate required to achieve the inflation target.
  • The MPC fixes the benchmark interest rate — or the base or reference rate that is used to set other interest rates — in India.
• Members of MPC
  • Section 45ZB says the MPC shall consist of:
    •  the RBI Governor as its ex officio chairperson,
    • the Deputy Governor in charge of monetary policy,
    • an officer of the Bank to be nominated by the Central Board
    • and three persons to be appointed by the central government having knowledge and experience in the field of economics or banking or finance or monetary policy.

Policy Stances of the MPC: Accommodative: An accommodative stance means the central bank is prepared to expand the money supply to boost economic growth. The central bank, during an accommodative policy period, is willing to cut the interest rates. A rate hike is ruled out. The Reserve Bank of India (RBI) has been on an accommodative stance for the last two years to support the economy during the COVID-19 crisis. Neutral: A ‘neutral stance’ suggests that the central bank can either cut-rate or increase the rate.  The interest rate can move to either sides depending on incoming data. Hawkish: A hawkish stance indicates that the central bank’s top priority is to keep inflation low.  During such a phase, the central bank is willing to hike interest rates to curb money supply and thus reduce the demand. Calibrated Tightening: Calibrated tightening means during the current rate cycle, a cut in the repo rate is off the table. But the rate hike will happen in a calibrated manner. This means the central bank may not go for a rate increase in every policy meeting, but the overall policy stance is tilted towards a rate hike.

RBI Repo Rate Hike by 50 bps to 5.4%: Why?

• “With inflation expected to remain above elevated levels, the MPC further calibrated withdrawal of monetary policy accommodation and accordingly it decided to increase the repo rate by 50 basis points.
• Calibrated accommodation is to keep inflation within the target along with supporting growth.

What is Monetary Policy? Monetary policy is the macroeconomic policy laid down by the Central bank. It involves management of the money supply in the the economy through interest rate to achieve macroeconomic objectives like inflation, consumption, growth and liquidity. Factor Affecting RBI’s Monetary Policy: Consumer Price Index (Inflation): Higher CPI means people have more money than they are required. If inflation is extremely high RBI will increase the rate of Interest. Strength of Financial Sectors: If banks in the country are functioning in a better manner, or when the transition of policy interest rate from RBI to the consumer is smooth and banks are not finding any difficulty to charge higher or lower. RBI will keep their policy interest rate accommodative. Balance of Payment (BoP): Higher negative Balance of Payment shows people are importing more and exporting less, it simply means people having more money to spend than required. In this case, the RBI will increase the interest rate. Employment Generation: If employment generation is low, RBI will reduce the rate of interest to increase the money supply in the economy to generate employment. Key Terms related to Monetary Policy: Repo Rate: Repo rate is the rate at which the central bank of a country (Reserve Bank of India in case of India) lends money to commercial banks in the event of any shortfall of funds.  It is used by monetary authorities to control inflation. If the repo rate increases, it means banks are getting funds from RBI at a higher cost. This, in turn, will mean that banks will also lend to others at a higher cost. For Example: So, if a person takes out a loan from a bank when the repo rate is high, he will have to pay a higher interest rate. Reverse Repo Rate:  This is the rate at which the Central bank of a country (RBI) borrows money from commercial banks. It is generally lower than the repo rate, at any point of time. It is used to control cash flow in the market. To absorb this excess liquidity, the central bank takes out money from the overall system by borrowing the money from banks. The banks benefit from this as they earn interest for their holdings with the central bank. Marginal Standing Facility: MSF or marginal standing facility is a system of the Reserve Bank of India that allows scheduled commercial banks to avail funds overnight.  The interest rate charged by RBI on such borrowings is called the MSF rate or marginal standing facility rate. It helps scheduled banks when interbank liquidity completely dries up and they are in urgent need of money. Bank Rate:  It is the rate at which the RBI is ready to buy or rediscount bills of exchange or other commercial papers. Cash Reserve Ratio (CRR): CRR is the average daily balance that a bank is required to maintain with the RBI as a share of such percent of its net demand and time liabilities (NDTL) that the RBI may notify from time to time in the Gazette of India. Open Market Operations: Open Market Operations include both, outright purchase and sale of government securities, for injection and absorption of durable liquidity, respectively. Standing Deposit Facility (SDF): This concept was first recommended by the Urjit Patel committee report in 2014. In 2018, the amended Section 17 of the RBI Act empowered the Reserve Bank to introduce the SDF. A Standing Deposit Facility allows the RBI to absorb liquidity (deposit) from commercial banks without any collateral. By removing the binding collateral constraint on the RBI, the SDF strengthens the operating framework of monetary policy. The SDF is also a financial stability tool in addition to its role in liquidity management. It will replace the fixed rate reverse repo (FRRR) as the floor of the liquidity adjustment facility corridor.