From UPSC perspective, the following things are important :
Prelims level : Repo Rate
Mains level : Inflation targetting by MPC
The Reserve Bank of India (RBI), in a sudden move, raised the repo rate by 40 basis points (bps) to 4.4% citing inflation that was globally rising alarmingly and spreading fast.
Why in news?
- The repo rate increase was the first since August 2018.
- The MPC retained its ‘accommodative’ policy stance even as it focuses on withdrawal of accommodation to keep inflation within the target range while supporting growth.
- Due to Ukraine War, persistent and spreading inflationary pressures are becoming more acute with every passing day.
Hues over the REPO spike
- The move — to have such a meeting and to raise the interest rates — is, at two different levels, both surprising and obvious.
- It is surprising because the RBI’s MPC meets once every two months — and the meeting this week was not scheduled.
What is 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.
- In the event of inflation, central banks increase repo rate as this acts as a disincentive for banks to borrow from the central bank.
- This ultimately reduces the money supply in the economy and thus helps in arresting inflation.
How does the repo dynamics work?
- 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.
- 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 loan, 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.
What is accommodative stance of policy?
- Accommodative monetary policy is when central banks expand the money supply to boost the economy. Monetary policies that are considered accommodative include lowering the Federal funds rate.
- These measures are meant to make money less expensive to borrow and encourage more spending.
What triggered the RBI to take sudden decision?
- Inflation has been rising for over two years: By law, the RBI is supposed to target retail inflation at 4%. Inflation constantly above 4% since last year.
- Inflation has not been “transitory”: The reasons for high inflation have tended to change over the months due to wide range of reasons like war, crude oil prices rise, taxes on fuels etc.
- Spike in crude oil prices is not new: The RBI has pointed to high crude oil prices in the wake of the Ukraine war, as one of the key reasons for high inflation in India.
- High core inflation: The core inflation which is essentially the inflation rate stripped of the effect of fuel and food prices has been rising up. This is more worrisome for RBI since it cannot be altered overnight.
- Monetary policy has lags. RBI waited too long: If the RBI wanted to contain inflation in May, it should have acted in February or at least in April. Raising rates right now may not bring down the inflation rate immediately.
Try this PYQ from CSP 2020:
Q.If the RBI decides to adopt an expansionist monetary policy, which of the following it would NOT do?
- Cut and optimize the statutory liquidity ratio
- Increase the Marginal Standing Facility Rate
- Cut the Bank Rate and Repo Rate
Select the correct answer using the code given below:
(a) 1 and 2 only
(b) 2 only
(c) 1 and 3 only
(d) 1, 2 and 3
Post your answers here:
Back2Basics: Monetary Policy Committee (MPC)
- The Monetary Policy Committee (MPC) is a committee of the RBI, which is entrusted with the task of fixing the benchmark policy interest rate (repo rate) to contain inflation within the specified target level.
- The RBI Act, 1934 was amended by Finance Act (India), 2016 to constitute MPC to bring more transparency and accountability in fixing India’s Monetary Policy.
- The policy is published after every meeting with each member explaining his opinions.
- The committee is answerable to the Government of India if the inflation exceeds the range prescribed for three consecutive months.
- Suggestions for setting up a MPC is not new and goes back to 2002 when YV Reddy committee proposed to establish an MPC, then Tarapore committee in 2006, Percy Mistry committee in 2007, Raghuram Rajan committee in 2009 and then Urjit Patel Committee in 2013.
Composition and Working
- The committee comprises six members – three officials of the RBI and three external members nominated by the Government of India.
- The meetings of the Monetary Policy Committee are held at least 4 times a year and it publishes its decisions after each such meeting.
- The Governor of RBI is the chairperson ex officio of the committee.
- Decisions are taken by a majority with the Governor having the casting vote in case of a tie.
- They need to observe a “silent period” seven days before and after the rate decision for “utmost confidentiality”.