RBI Hikes Key Interest Rate By 35 BPS

Context:

Signalling a further rise in lending and deposit rates, the Monetary Policy Committee (MPC) of the Reserve Bank of India on Wednesday (December 7) hiked the key policy rate, the repo rate or the rate at which the RBI lends funds to banks, by 35 basis points to 6.25 per cent in a bid to rein in retail inflation.

• The MPC also lowered its growth forecast to 6.8 per cent from 7 per cent for the current financial year amid concerns over the “bleak” global economic outlook, and retained its retail inflation forecast at 6.7 per cent.

Relevance:

GS III- Indian Economy

Dimensions of the Article:

1. Instruments of Monetary Policy
2. Why did the Monetary Committee raise the rate?
3. What will be the impact?
4. What does the Repo rate hike mean?
5. About Monetary Policy Committee (MPC)

Instruments of Monetary Policy

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

1. 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).
2. 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.
3. 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.
4. 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.
5. Corridor: The MSF rate and reverse repo rate determine the corridor for the daily movement in the weighted average call money rate.
6. 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.
7. 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.
8. 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.
9. Open Market Operations (OMOs): These include both, outright purchase and sale of government securities, for injection and absorption of durable liquidity, respectively.
10. 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.

Why did the Monetary Committee raise the rate?

• The RBI has hiked the policy rate in a bid to bring down inflation from the current level.
• Inflation in October eased to 6.77 per cent, a three-month low, but it remains well above the RBI’s comfort level of 4 per cent.
• But the worry for the central bank is the rise in core inflation — the non-food, non oil part of inflation — that edged up again after moderating over the summer.
• Also households’ inflation expectations remain high as food price inflation continues to remain elevated.
• Weakness in the rupee against the US dollar is adding to inflationary concerns at the RBI given that a third of the CPI basket consists of import.

What will be the impact?

• Equated monthly instalments (EMIs) on home, vehicle and other personal and corporate loans are likely to go up.
• Deposit rates are also set to rise after the Repo rate hike that came after nearly four years.
• By hiking the Repo rate and CRR, the RBI is aiming to keep inflation – which is already close to 7 per cent — at its desired level, and control and monitor money flow into the banking system at a time when the global economy is facing turbulent times.

What does the Repo rate hike mean?

• The hike in Repo rate – the key policy rate of RBI or the rate at which it lends to banks – means the cost of funds for banks will go up.
• This will prompt banks and NBFCs to raise the lending and deposit rates in the coming days.
• However, analysts say that consumption and demand can be impacted by the Repo rate hike.
• The RBI last hiked the Repo rate by 25 bps to 6.50 per cent in August 2018.

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, Indian Express