In its third bimonthly policy, the Reserve Bank of India (RBI) increased the repo rate by a quarter percent to 6.5%, due to concerns over inflation. This action is underpinned by several contributing factors such as rising inflation rates and economic uncertainties. This increase will inevitably push up loan costs for borrowers, as banks are likely to raise interest rates accordingly.
Understanding the Increase on Repo Rate
The RBI has hiked the repo rate by 25 basis points (bps), with one bps being equivalent to 0.01%. This implies that the increase stands at 0.25%. There are compelling reasons behind this upward revision: The need to control retail inflation, which quickened to 5% in June 2018, domestic and global uncertainties, possible HRA revisions by state governments that could push housing inflation, uncertainties in global financial markets, risk of fiscal slippage by the Centre or States, significant hikes in minimum support price (MSP), and volatility in crude oil prices.
The 2016 Amendment of RBI Act and Its Influence on Monetary Policy
The RBI Act of 1934 was amended in 2016, introducing an inflation target system wherein the Government of India, in consultation with the RBI, sets the inflation target every five years. As per this directive, the government has notified 4% CPI inflation as the target from August 5, 2016, to March 31, 2021. The upper tolerance limit for this target is 6%, with a lower limit of 2%.
Monetary Policy Committee (MPC) – Role and Composition
The 2016 amendment also led to the creation of the Monetary Policy Committee (MPC). Constituting six members, including three RBI officials and three external members nominated by the Government of India, it aims to ensure transparency and accountability in determining monetary policy. The MPC determines the benchmark policy interest rate (repo rate) to keep inflation within the stipulated target level.
The Implications of a Repo Rate Increase on Borrowers
The recent hike in repo rate will likely make loans more costly for borrowers, as banks are expected to raise the interest rates on loans in line with this increase. It’s because an increase in repo rate implies a probable rise in banks’ Marginal Cost-Based Lending Rate (MCLR). This is the first time since October 2013 that the repo rate has been increased in two consecutive policy meetings.
Prospects for Growth Outlook
Despite these challenges, the RBI maintained the GDP forecast at 7.4% for the current fiscal year, driven by factors like strong corporate earnings, particularly among fast-moving consumer goods (FMCG) companies, buoyant rural demand fueled by MSP hikes, favourable monsoon weather, and increasing investments. The GDP is also projected to be between 7.5-7.6% in the second half of the current fiscal year.
Instruments of Monetary Policy
Some of the key implements of monetary policy include the Liquidity Adjustment Facility (LAF), Repo Rate, Reverse Repo Rate, and Marginal Cost of funds based Lending Rate (MCLR). All these tools play crucial roles in maintaining financial stability in the market, regulating liquidity in the banking system, and managing lending practices.