Repo Rate Hike

Why in news?

• The monetary policy committee (MPC) of the RBI has decided to increase the repo rate by 25 basis points.

What is a repo rate?

• Repurchase rate or the repo rate is the rate at which the RBI lends money to commercial banks.
• This is availed by the banks in the event of any shortfall of funds.
• Reverse repo is the rate at which the RBI borrows money from commercial banks within the country.
• RBI has now increased the repo rate by 25 basis points to 6.5% in the recent MPC meet.
• The Reverse repo is adjusted to 6.25 per cent.

What are the driving factors?

• Inflation - Fear of rising inflation rates has been a major factor for raising the policy rates.
• According to the RBI, inflation outlook is likely to be shaped by several factors:
• 1) The foremost is the government’s decision to increase the minimum support price (MSP) for kharif crops.
• MSP hike may have a direct impact on food inflation and eventually on headline inflation.
• 2) The gradual impact of HRA (house rent allowance) revision by state governments could push inflation further up.
• 3) There is a continuing volatility in crude oil prices and is also vulnerable to geopolitical tensions.
• The resultant supply disruptions is one of the main risks to the inflation outlook.
• 4) Rainfall has so far been 6% below the long-period average and deficient over a wider area than last year.
• This has resulted in a drop in the total sown area under kharif.
• Regional imbalances in rainfall could pose risks to paddy output and eventually reflect in CPI inflation.
• 5) The recent round of the RBI’s survey of households also reported a rising inflationary trend.
• 6) Moreover, RBI's inflation projection stands at 5% in the first quarter of 2019-20.
• It has projected inflation at 4.6% in Q2 and 4.8% in the second half of the financial year 2018-19, with risks evenly balanced.
• So the overall inflation trend demands that India opt for a tight policy (higher rates).
• Currency - The recent global trade war has resulted in competitive currency devaluation.
• In the event of a currency war, the domestic currency has to give way for depreciation pressure of the region.
• But depreciation is likely to contribute to the vulnerability of the economy. Click here to know more
• Thus, avoiding such risks is essential for ensuring macroeconomic stability.
• It is also crucial for maximising the chances of a growth profile of 7 to 7.5% in India.
• A rate hike by the central bank thus attempts to strengthen the currency and avoid getting affected by the currency war.
• Recovery - The MPC was for long wary of an interest rate hike due to the impact it could have on growth prospects.
• However, there was an increased output of the eight core industries in the recent period.
• This suggested that the economic recovery was back on track.
• It was thus convincing for MPC to now focus on containing headline inflation.
• Given all these, the rate hike seems to be a right measure at the right time to ensure growth as well as avoid risks.

Why a neutral stance?

• Given the projected inflationary risks, there were widespread demands for higher policy rates.
• But the RBI has maintained fairly a neutral policy stance.
• This means that RBI has made only a marginal increase which is proportionately lesser to the inflation projections.
• One of the reasons is that the risks that are cited as the factors for the rate hike are not well established.
• Primarily, the CPI inflation risks are only a projection, though informed, with a fair bit of uncertainty.
• Hence a neutral stance would help accommodate the upcoming domestic and external uncertainties.
• This could be in relation with the

1. impact of government’s policies
2. oil price direction
3. trade disputes and impact on global growth
4. US rate trajectory

• So according to RBI, a neutral stance would keep the policy options open for any future economic scenario.

Source: The Hindu, Business Standard, BusinessLine