The Reserve Bank of India (RBI) recently declared its decision to maintain the benchmark policy rate at 6.5%. Indicating a shift from neutral to calibrated tightening, it has laid down that future rates will either increase or remain constant. This change is directed by the Monetary Policy Committee (MPC), a statutory organization set up under the Reserve Bank of India Act, 1934.
Understanding the Monetary Policy Committee
The MPC includes six members, three from the RBI, and three appointed by the government. The Governor of RBI serves as the ex-officio Chairman of the committee. The main objective of MPC is to maintain price stability while keeping growth in mind. The MPC is responsible for determining the policy interest rate, known as the repo rate, required to achieve the inflation target. It was recommended in 2014 by an RBI-appointed committee led by the then deputy governor Urjit Patel.
Instruments of Monetary Policy
The RBI uses several monetary tools to implement its policies. These include the Repo Rate, Reverse Repo Rate, Liquidity Adjustment Facility (LAF), Marginal Standing Facility (MSF), Bank Rate, Cash Reserve Ratio (CRR), Statutory Liquidity Ratio (SLR), Open Market Operations (OMOs), and Market Stabilisation Scheme (MSS).
Repo Rate and Reverse Repo Rate
The Repo Rate is the interest rate at which the RBI lends money to banks against government and approved securities under LAF. Similarly, the Reverse Repo Rate is the rate at which the RBI borrows money from banks against eligible government securities.
Liquidity Adjustment Facility and Marginal Standing Facility
The LAF allows the RBI to adjust the money supply in the economy by enabling banks to borrow money through repurchase agreements. The MSF is a special window for banks to borrow from the RBI in emergencies, such as acute cash shortages, at higher rates than the Repo Rate.
Bank Rate and Cash Reserve Ratio
The Bank Rate is the long-term interest rate at which the RBI lends to other banks or financial institutions but is not typically used for monetary management. The CRR is a mandatory proportion of bank deposits held in cash, restricting bank access to this amount for economic or commercial activities.
Statutory Liquidity Ratio and Open Market Operations
The SLR mandates banks to maintain a certain share of Net Demand and Time Liabilities in safe and liquid assets, offering some interest earnings unlike the CRR. OMOs involve buying and selling government securities by the RBI for managing liquidity.
Market Stabilisation Scheme
The MSS was introduced in 2004 to absorb surplus liquidity arising from large capital inflows through the sale of short-dated government securities and treasury bills. The collected cash is held in a separate government account with the RBI.
