RBI Keeps Benchmark Interest Rate Unchanged

Context:

The Reserve Bank of India (RBI) maintained its repo rate at 6.50% for the tenth successive monetary policy review since April 2023.

Relevance:

GS III- Indian Economy

Dimensions of the Article:

1. Details
2. What is the repo rate?
3. Why is the repo rate such a crucial monetary tool?
4. How does the repo rate work?
5. What impact can a repo rate change have on inflation?
6. Recent Monetary Policy and RBI Decisions
7. Instruments of Monetary Policy
8. About Monetary Policy Committee (MPC)

Details:

• Following the Monetary Policy Committee (MPC) meeting, RBI Governor announced the decision to keep the policy repo rate steady at 6.5% for the tenth time in a row.
• Other key rates also remained unchanged, with the standing deposit facility (SDF) rate at 6.25% and both the marginal standing facility (MSF) rate and the bank rate at 6.75%.
• The MPC has decided to change the stance of monetary policy to neutral while remaining unambiguously focused on a durable alignment of inflation with the target, alongside supporting growth.

What is the repo rate?

• The repo rate is one of several direct and indirect instruments that are used by the RBI for implementing monetary policy.
• Specifically, the RBI defines the repo rate as the fixed interest rate at which it provides overnight liquidity to banks against the collateral of government and other approved securities under the liquidity adjustment facility (LAF).
• In other words, when banks have short-term requirements for funds, they can place government securities that they hold with the central bank and borrow money against these securities at the repo rate.
• Since this is the rate of interest that the RBI charges commercial banks such as State Bank of India and ICICI Bank when it lends them money, it serves as a key benchmark for the lenders to in turn price the loans they offer to their borrowers.

Why is the repo rate such a crucial monetary tool?

• According to Investopedia, when government central banks repurchase securities from commercial lenders, they do so at a discounted rate that is known as the repo rate.
• The repo rate system allows central banks to control the money supply within economies by increasing or decreasing the availability of funds.

How does the repo rate work?

• Besides the direct loan pricing relationship, the repo rate also functions as a monetary tool by helping to regulate the availability of liquidity or funds in the banking system.
• For instance,
  • When the repo rate is decreased,
    • Banks may find an incentive to sell securities back to the government in return for cash. This increases the money supply available to the general economy.
  • When the repo rate is increased,
    • Lenders would end up thinking twice before borrowing from the central bank at the repo window thus, reducing the availability of money supply in the economy.
• Since inflation is, in large measure, caused by more money chasing the same quantity of goods and services available in an economy, central banks tend to target regulation of money supply as a means to slow inflation.

What impact can a repo rate change have on inflation?

• Inflation can broadly be: mainly demand driven price gains, or a result of supply side factors that in turn push up the costs of inputs used by producers of goods and providers of services, thus spurring inflation, or most often caused by a combination of both demand and supply side pressures.
• Changes to the repo rate to influence interest rates and the availability of money supply primarily work only on the demand side by making credit more expensive and savings more attractive and therefore dissuading consumption.
• However, they do little to address the supply side factors, be it the high price of commodities such as crude oil or metals or imported food items such as edible oils.

Instruments of Monetary Policy

There are several direct and indirect instruments that are used for implementing monetary policy.

• Repo Rate: The (fixed) interest rate at which the Reserve Bank provides overnight liquidity to banks against the collateral of government and other approved securities under the liquidity adjustment facility (LAF).
• Reverse Repo Rate: The (fixed) interest rate at which the Reserve Bank absorbs liquidity, on an overnight basis, from banks against the collateral of eligible government securities under the LAF.
• Liquidity Adjustment Facility (LAF): The LAF consists of overnight as well as term repo auctions. Progressively, the Reserve Bank has increased the proportion of liquidity injected under fine-tuning variable rate repo auctions of range of tenors. The aim of term repo is to help develop the inter-bank term money market, which in turn can set market based benchmarks for pricing of loans and deposits, and hence improve transmission of monetary policy. The Reserve Bank also conducts variable interest rate reverse repo auctions, as necessitated under the market conditions.
• Marginal Standing Facility (MSF): A facility under which scheduled commercial banks can borrow additional amount of overnight money from the Reserve Bank by dipping into their Statutory Liquidity Ratio (SLR) portfolio up to a limit at a penal rate of interest. This provides a safety valve against unanticipated liquidity shocks to the banking system.
• Corridor: The MSF rate and reverse repo rate determine the corridor for the daily movement in the weighted average call money rate.
• Bank Rate: It is the rate at which the Reserve Bank is ready to buy or rediscount bills of exchange or other commercial papers. The Bank Rate is published under Section 49 of the Reserve Bank of India Act, 1934. This rate has been aligned to the MSF rate and, therefore, changes automatically as and when the MSF rate changes alongside policy repo rate changes.
• Cash Reserve Ratio (CRR): The average daily balance that a bank is required to maintain with the Reserve Bank as a share of such per cent of its Net demand and time liabilities (NDTL) that the Reserve Bank may notify from time to time in the Gazette of India.
• Statutory Liquidity Ratio (SLR): The share of NDTL that a bank is required to maintain in safe and liquid assets, such as, unencumbered government securities, cash and gold. Changes in SLR often influence the availability of resources in the banking system for lending to the private sector.
• Open Market Operations (OMOs): These include both, outright purchase and sale of government securities, for injection and absorption of durable liquidity, respectively.
• Market Stabilisation Scheme (MSS): This instrument for monetary management was introduced in 2004. Surplus liquidity of a more enduring nature arising from large capital inflows is absorbed through sale of short-dated government securities and treasury bills. The cash so mobilised is held in a separate government account with the Reserve Bank.

About Monetary Policy Committee (MPC)

• The Monetary Policy Committee (MPC) is the body of the RBI, headed by the Governor, responsible for taking the important monetary policy decisions about setting the repo rate.
• Repo rate is ‘the policy instrument’ in monetary policy that helps to realize the set inflation target by the RBI (at present 4%).

Membership of the MPC

• The Monetary Policy Committee (MPC) is formed under the RBI with six members.
• Three of the members are from the RBI while the other three members are appointed by the government.
• Members from the RBI are the Governor who is the chairman of the MPC, a Deputy Governor and one officer of the RBI.
• The government members are appointed by the Centre on the recommendations of a search-cum-selection committee which is to be headed by the Cabinet Secretary.

Objectives of the MPC

Monetary Policy was implemented with an initiative to provide reasonable price stability, high employment, and a faster economic growth rate.

The major four objectives of the Monetary Policy are mentioned below:

• To stabilize the business cycle.
• To provide reasonable price stability.
• To provide faster economic growth.
• Exchange Rate Stability.

-Source: The Hindu, The Indian Express