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A Pragmatic Move By RBI


The Reserve Bank of India holds increase in the policy rate surprises most banks and economy analysts.


GS III- Indian Economy

Dimensions of the Article:

  1. RBI pause repo rate hike
  2. Reasons for the pause in policy rate
  3. Instruments of Monetary Policy
  4. About Monetary Policy Committee (MPC)

RBI pause repo rate hike:

  • The pause in repo rate hikes comes after the RBI increased the key interest rates six times since May last year.
  • The consensus view among analysts is that this could well mark the end of the current rate tightening cycle.
  • RBI governor Shaktikanta Das stressed that the pause was “this meeting only” — and that MPC could start cutting rates from April 2024.
  • The pause has been triggered by turbulence in the global macroeconomic and financial climate.

Reasons for the pause in policy rate:

  1. Inflation:
    • While it was over 6%, the upper limit of RBI’s tolerance band in February (at 6.44%), it is expected to come down this year.
    • MPC’s resolution expects it to be 5.2% for the entire year (2023-24), and 5.1%, 5.4%, 5.4%, and 5.2% in each of the four quarters.
    • Increasing Crude oil prices and than expected winter crop on account of recent weather events could aggravate inflation.
  2. Growth:
    • MPC marginally increased its growth forecast for 2023-24 from 6.4% to 6.5%, with an estimate of 7.8%, 6.2%, 6.1%, and 5.9% across the four quarters.
    • A great barrier to this are all global — geopolitical tensions and a churn in the global financial market.
  3. Financial Stability:
    • Recent developments in US and European banks have sent shock waves through the global financial system, raising prospects of a 2008-style global financial crisis.
  4. Apart from these reasons, a rapid rate tightening since May has increased interest rate by 2.5 percentage points. It has affected retail borrowers, hence the pause should provide some relief.  

Instruments of Monetary Policy

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

  1. Repo rate
    • The central bank has retained the repo rate – the rate at which the RBI lends funds to banks – at 4 per cent to boost growth.
    • This means banks won’t hike lending and deposit rates and EMIs on loans will remain unchanged.
    • The RBI has reduced key policy repo rate by 115 bps to 4.0 per cent and reverse repo rates by 155 bps to 3.35 per cent since February 2020.
    • Banks had since then reduced their interest rates (both deposits and lending) significantly.
    • The large size of the FY23 market borrowings, and with no progress on the inclusion of Indian debt market in the global bond indices, might have prompted the RBI to delay the liquidity normalisation in an effort to keep the cost of large borrowings programme under control, said an analyst.
    • It also retained the marginal standing facility (MSF) rate, and kept the Bank Rate unchanged at 4.25 per cent.
  1. 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.
  2. 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.
  3. 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.
  4. Corridor: The MSF rate and reverse repo rate determine the corridor for the daily movement in the weighted average call money rate.
  5. 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.
  6. 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.
  7. 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.
  8. Open Market Operations (OMOs): These include both, outright purchase and sale of government securities, for injection and absorption of durable liquidity, respectively.
  9. 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.

February 2024