RBI rate Increase

The news: Important points
  • The Reserve Bank of India's Monetary Policy Committee (MPC) raised the policy repo rate by 50 bps to 5.4%.
  • Since inflation is expected to stay over the upper tolerance limit of 6 per cent for the first three quarters of 2022–2023, the increase is justified in order to avoid destabilising inflation expectations and causing ripple effects.
  • Given the high level of inflation and resilient domestic economic activity, more calibrated monetary policy action is needed to limit inflationary pressures, bringing headline inflation closer to the target, and anchor inflation expectations to ensure sustained growth.
  • The MPC also stated that it would continue to concentrate on "withdrawal of accommodation" in order to maintain target inflation while promoting growth.
  • The RBI projected 6.7% inflation and 7.2% GDP growth for the current fiscal year ending in March 2023.
  • Governor Shaktikanta Das said the RBI would do "whatever it takes" to ensure a soft landing for the economy.
  • The RBI governor stated that the response to the unfolding economic situation would be "calibrated, measured, and nimble."
  • There are indications that Consumer Price Inflation (CPI) peaked in the third quarter and is anticipated to moderate in the fourth quarter.
  • However, inflation remains uncomfortably and unacceptably high.
  • As a result, monetary policy must take action, as numerous uncertainties cloud the outlook.
  • Further, the system's excess liquidity was being gradually reduced.
  • In the external sector, the Current Account Deficit (CAD) would remain within manageable limits, and the Reserve Bank of India (RBI) would be able to finance the CAD.
  • The foreign exchange reserves remain robust, the RBI will effectively manage excessive exchange rate volatility, and the umbrella remains robust.
The Terminologies Involved 1. Repo Rate
  • It is the interest rate at which the central bank of a country lends money to commercial banks.
  • The central bank in India i.e. the Reserve Bank of India (RBI) uses the repo rate to regulate liquidity in the economy.
  • In banking, the repo rate is related to the ‘repurchase option’ or ‘repurchase agreement’.
  • When there is a shortage of funds, commercial banks borrow money from the central bank which is repaid according to the repo rate applicable.
  • The central bank provides these short terms loans against securities such as treasury bills or government bonds.
  • This monetary policy is used by the central bank to control inflation or increase the liquidity of banks.
  • The government increases the repo rate when they need to control prices and restrict borrowings.
  • On the other hand, the repo rate is decreased when there is a need to infuse more money into the market and support economic growth.
  • An increase in repo rate means commercial banks have to pay more interest for the money lent to them and therefore, a change in repo rate eventually affects public borrowings such as home loans, EMIs, etc.
  • From interest charged by commercial banks on loans to the returns from deposits, various financial and investment instruments are indirectly dependent on the repo rate.

Reverse Repo Rate

  • This is the rate the central bank of a country pays its commercial banks to park their excess funds in the central bank.
  • The reverse repo rate is also a monetary policy used by the central bank to regulate the flow of money in the market.
  • When in need, the central bank of a country borrows money from commercial banks and pays them interest as per the reverse repo rate applicable.
  • At a given point in time, the reverse repo rate provided by RBI is generally lower than the repo rate.
  • While the repo rate is used to regulate liquidity in the economy, the reverse repo rate is used to control cash flow in the market.
  • When there is inflation in the economy, RBI increases the reverse repo rate to encourage commercial banks to make deposits in the central bank and earn returns. This in turn absorbs excessive funds from the market and reduces the money available for the public to borrow.
2. Monetary Policy Committee (MPC)
  • Under the Reserve Bank of India, Act,1934 (RBI Act,1934) (as amended in 2016), RBI is entrusted with the responsibility of conducting monetary policy in India with the primary objective of maintaining price stability while keeping in mind the objective of growth.

The Monetary Policy Framework

  • The amended RBI Act, 1934 provides for an empowered six-member monetary policy committee (MPC) to be constituted by the Central Government by notification in the Official Gazette. The first such MPC was constituted on September 29, 2016.
  • The present MPC members, as notified by the Central Government in the Official Gazette of October 5, 2020, are as under:
  1. Governor of the Reserve Bank of India—Chairperson, ex officio.
  2. Deputy Governor of the Reserve Bank of India, in charge of Monetary Policy—Member, ex officio.
  3. One officer of the Reserve Bank of India to be nominated by the Central Board—Member, ex officio.
  4. Ashima Goyal, Professor, Indira Gandhi Institute of Development Research —Member.
  5. Jayanth R. Varma, Professor, Indian Institute of Management, Ahmedabad—Member; and
  6. Shashanka Bhide, Senior Advisor, National Council of Applied Economic Research, Delhi—Member.
3. Inflation
  • Inflation is the rate of increase in prices over a given period of time. Inflation is typically a broad measure, such as the overall increase in prices or the increase in the cost of living in a country.
  • It can also be more narrowly calculated—for certain goods, such as food, or for services, such as a haircut, for example.
  • Whatever the context, inflation represents how much more expensive the relevant set of goods and/or services has become over a certain period, most commonly a year.
4. Headline Inflation
  • Headline inflation is the raw inflation figure reported through the Consumer Price Index (CPI).
  • The CPI determines inflation by calculating the prices on a fixed basket of goods.
  • Core inflation removes the CPI components that can exhibit large amounts of volatility from month to month.
5. Consumer Price Inflation (CPI)
  • The Consumer Price Index (CPI) measures the price change of goods and services from the consumer's perspective.
  • The National Statistical Office issues it (NSO).
  • The CPI measures the difference between the prices of commodities and services that Indian consumers purchase for consumption, such as food, medical care, education, and electronics.
  • Food and beverages, fuel and light, housing and clothing, bedding, and footwear are subgroups of the CPI.
  • Four types of CPI are as follows:
    • CPI for Industrial Workers (IW).
    • CPI for Agricultural Labourer (AL).
    • CPI for Rural Labourer (RL).
    • CPI (Rural/Urban/Combined).
  • The Labour Bureau within the Ministry of Labour and Employment is responsible for compiling the first three. The NSO in the Ministry of Statistics and Programme Implementation compiles the fourth.
  • The CPI base year is 2012.
  • Recently, the Ministry of Labour and Employment released the new series of the Industrial Worker Consumer Price Index (CPI-IW) with 2016 as the base year.
  • The Monetary Policy Committee (MPC) controls inflation using CPI data. The Reserve Bank of India (RBI) adopted the CPI as its primary measure of inflation in April 2014.
6. Current Account Deficit (CAD)
  • The current account deficit is a measurement of a country's trade when the value of its imports exceeds its exports.
  • Net income, such as interest and dividends, and transfers, such as foreign aid, are included in the current account, although they represent a small portion of the total current account.
  • Similar to the capital account, the current account represents a country's foreign transactions and is a component of its balance of payments (BOP).
Posted by V.P.Nimbalkar on 6th Aug 2022