As part of its recent Monetary Policy Committee (MPC) review, the Reserve Bank of India (RBI) announced a 50-basis point hike in repo rates. This resulted in a cumulative rate increase of 140 basis points over the last three months. This article will delve into the particulars of this decision and its impact on India’s economic environment.
Key Rates Detailed
The policy repo rate now sits at 5.40%. This is the interest rate at which the RBI lends money to commercial banks in case of a funds shortfall. The Standing Deposit Facility (SDF) follows closely behind at 5.15%. The SDF permits banks to park any excess liquidity with the RBI without the requirement of collateral.
Next, the Marginal Standing Facility Rate (MSFR) is at 5.65%. This is an emergency lending scheme for banks when interbank liquidity dries up fully. The bank rate is also pegged at 5.65%—the rate the RBI charges when lending funds to commercial banks.
Finally, the Cash Reserve Ratio (CRR) is 4.50%, mandating that commercial banks hold a certain minimum amount of deposit as reserves with the central bank, and the Statutory Liquidity Ratio (SLR) is 18%, which is the minimum percentage of deposits that a bank has to keep in cash, gold or other approved securities.
Projections: GDP Growth and Inflation
The RBI’s projection for GDP growth for the financial year 2022-23 stands at 7.2%. Gross Domestic Product, in essence, measures the economic output from the consumer’s perspective.
On the inflation front, the RBI projects inflation at 6.7% for the same period. Inflation represents the rate of increase in prices over time and is a broad measure of the overall increase in prices or the increase in the cost of living.
Repo Rate Hike: The Rationale
Despite consumer price inflation easing from its April 2022 surge, expected levels remain uncomfortably high. These elevated levels of inflation were a significant concern for the MPC, as the government’s inflation target according to the RBI stands at 4% +/- 2%. Sustained high inflation may destabilise inflation expectations and jeopardise growth in the medium term. The repo rate hike is designed to contain this threat.
Impact on Borrowers and Depositors
The repo rate hike will impact home loan customers and borrowers by increasing lending rates. However, it will benefit conservative investors who keep their funds in bank fixed deposits, as deposit rates are likely to increase following the rate hike. This increase in deposit rates will not only help meet the economy’s credit demand but also assist banks in raising additional funds.
Liquidity Impact
While a rate hike improves the availability of funds with banks, it can cause a gradual decline in systemic liquidity over time. Therefore, to ensure adequate liquidity, the RBI plans to conduct two-way fine-tuning operations in the form of Variable Rate Repos and Reverse Repos.
Overview of Monetary Policy Framework
In May 2016, the RBI Act was amended to provide a legislative mandate to the central bank to operate the country’s monetary policy framework. This framework aims at setting the policy (repo) rate based on an assessment of the current and evolving macroeconomic situation, and modulating liquidity conditions to anchor money market rates around the repo rate.
Monetary Policy Committee
The Monetary Policy Committee (MPC), a six-member body, was constituted under Section 45ZB of the amended RBI Act of 1934. The committee determines the policy rate needed to achieve the inflation target.
Instruments of Monetary Policy
The various instruments of monetary policy include the repo rate, standing deposit facility (SDF) rate, marginal standing facility (MSF) rate, liquidity adjustment facility (LAF), reverse repo rate, bank rate, cash reserve ratio (CRR), statutory liquidity ratio (SLR), and open market operations (OMOs).
Expansionary vs Contractionary Monetary Policy
An expansionary monetary policy focuses on expanding the money supply in an economy, incentivising economic activity by lowering key interest rates. Conversely, a contractionary monetary policy is designed to decrease the money supply in an economy by increasing key interest rates, which can negatively impact production, consumption, and potentially economic growth.
