Reserve Bank of India (RBI) hikes repo rate by 25 basis points (bps) to 6.5% and has also projected a GDP growth for the next fiscal at 6.4%.
What are the current changes done by the RBI?
Repo Rate – It is the rate at which the central bank of a country (RBI, in case of India) lends money to commercial banks in the event of any shortfall of funds.
Repo rate is used by monetary authorities to control inflation.
Reverse repo rate – It is the rate at which the central bank of a country (RBI, in case of India) borrows money from commercial banks within the country.
It is a monetary policy instrument which can be used to control the money supply in the country.
During its meeting MPC has decided to keep the reverse repo rate unchanged at 3.35%.
Growth projection - The RBI has projected GDP growth for at 6.4% for the next fiscal as earlier projected 7% GDP growth is not achieved.
The projections are not achieved because of geopolitical tensions, global slowdown and tightening of global financial conditions.
Why RBI’s Monetary Policy Committee hiked the repo rate?
Inflation forecast - The central bank has lowered the inflation target from 6.7% to 6.5%, which is still above the RBI’s comfort level of 4%.
Inflation is expected to be 5.3% in FY24.
The hike will help in moderating inflation in the country.
What happens when Repo Rate and CRR is increased?
Cash reserve ratio (CRR) is the percentage of a bank's total deposits that it needs to maintain as liquid cash.
This is an RBI requirement, and the cash reserve is kept with the RBI.
A bank does not earn interest on this liquid cash maintained with the RBI and neither can it use this for investing and lending purposes.
If the Repo rate is hiked,
The banks will now have to pay a higher amount of interest to the RBI which in turn shall be collected from the retail/ corporate borrowers of the banks.
This would result in higher interest outflow on loans taken from the banks, thus the loans in general will become costlier by 1-2%.
When CRR is increased, it
Decreases money supply
Increases interest rates on home loans, car loans, etc.
Increases demand for money in inter-bank market
Decreases inflation
How this move will impact overall economy?
Lending rates of banks is expected to go up as the cost of funds is expected to rise further.
EMIs on vehicles, home and personal loans will also rise.
The external benchmark linked lending rate (EBLR) of banks will rise as such loans are linked to the Repo rate.
Some analysts say that consumption and demand can be impacted by the repo rate hike.
Marginal cost of funds-based lending rates (MCLR) which accounts for 49.2% of the loans portfolio of banks is also expected to move up.
What does accommodative stance mean with respect to monetary policy?
Accommodative monetary policy is a strategy used by central banks to keep interest rates low in order to infuse more cash into the economy to boost growth and maintain or reduce unemployment.
This policy tactic helps maintain economic stability in a time of crisis by keeping people working and helping businesses expand.
An accommodative monetary policy is often implemented during and after a crisis to provide support for the economy.
The goal is to keep employment and prices as stable as possible while the situation gets resolved.
While it has the major benefit of saving jobs, the low interest rates that result can hurt savers.
If the policy steps are successful, the resulting strong economy could become inflationary.
Quick facts
Marginal cost of funds-based lending rates (MCLR) – It is the minimum lending rate below which a bank is not permitted to lend.
Inflation – It is the rate of increase in prices over a given period of time.
