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RBI Rate Hike and Its Impact

Posted on June 9, 2022 by admin1  923

In News

  • Recently, the RBI raised its main policy rate and the Repo rate for the second time in over a month by an expected 50 basis points to control inflation.

About the recent hikes

  • Repo rate: The central bank has now raised the Repo rate by 90 basis points to 4.90 per cent.
    • Repo rate refers to the rate at which the RBI lends to commercial banks.
  • Growth projection: The Monetary Policy Committee of the RBI, in its bi-monthly policy review, has maintained its previous growth projection of 7.2 per cent for 2022-23.
  • The World Bank projections: had slashed its growth forecast for India for the current financial year to 7.5 per cent, a sharp 1.2 percentage points cut from its previous forecast of 8.7 percent.
  • Inflation: The RBI also projected inflation to rise to 7.5 per cent for April-June this year and 6.7 per cent for the full financial year, sharply up from the 5.7 per cent.

Impact on the economy

  • Impact on demand: The hikes are set to raise the lending rates in the banking system and impact the demand in the economy.
    • When interest rates are raised, it makes money more expensive, thereby resulting in reduction of demand in the economy and bringing down inflation.
  • High EMI’s: The rate hike will force banks and non-banking finance companies to increase lending rates and result in higher equated monthly instalments (EMIs) of existing borrowers.
  • New home, vehicle and personal loans will also become costlier.

Challenges

  • Escalating geopolitical tensions: Although India’s direct trade exposure to countries at the epicentre of the conflict is limited; the war could potentially impede the economic recovery through elevated commodity prices and global spill-over channels.
  • High inflation and Low growth: Generalised hardening of global commodity prices, the likelihood of prolonged supply chain disruptions, dislocations in trade and capital flows, divergent monetary policy responses and volatility in global financial markets are imparting sizeable upside risks to the inflation trajectory and downside risks to domestic growth.
  • Concerns over protracted supply disruptions have rattled global commodity and financial markets.

About Monetary Policy Committee (MPC)

  • Constituted by RBI under section 45ZB of the Reserve Bank of India (RBI) Act, 1934.
  • Chaired by the Governor of RBI. 
  • Mission: Fixing the benchmark policy interest rate (repo rate) to restrain inflation within the particular target level (2% to 6%). 
  • MPC conducts meetings at least 4 times a year. 
  • The monetary policy is published after every meeting with each member explaining his opinions.

 

Way forward/ Suggestions  

  • Improvement/ Recovery: RBI said that the economy remains resilient to global challenges and is witnessing recovery, towards rising rail, port and air traffic, GST collections, improving capacity utilisations, rise in bank credit disbursals and signs of improvement in rural and urban demand.
  • The central bank is now focussed on withdrawal of accommodative stance as the liquidity surplus remains higher than pre-pandemic levels whereas the rates are still below the pre-pandemic levels.
  • The forecast of a normal monsoon should boost kharif sowing and agricultural output.
    • This will support rural consumption.
  • Interest rate hike will help to ensure that growth is not affected as unchecked inflation can affect discretionary consumption, which in turn will affect growth.

Key Terminologies

  • Repo Rate: It is the rate at which the central bank of a country (Reserve Bank of India in case of India) lends money to commercial banks in the event of any shortfall of funds.
    • Repo stands for ‘repurchase option’ or ‘repurchase agreement’.
    • The central bank provides these short term loans against securities such as treasury bills or government bonds.
    • It is commonly known as Policy Rate too.
    • Repo rate is used by monetary authorities to control inflation.
    • The government increases the repo rate when they need to control prices and restrict borrowings.
    • On the other hand, the repo rate is decreased when there is a need to infuse more money into the market and support economic growth.
  • Reverse Repo Rate: This is the rate the central bank of a country pays its commercial banks to park their excess funds in the central bank.
    • The reverse repo rate provided by RBI is generally lower than the repo rate.
    • While repo rate is used to regulate liquidity in the economy, reverse repo rate is used to control cash flow in the market.
    • When there is inflation in the economy, RBI increases the reverse repo rate.
      • It encourages commercial banks to make deposits in the central bank and earn returns.
  • Marginal Standing Facility: MSF or marginal standing facility is a system of the Reserve Bank of India that allows scheduled commercial banks to avail funds overnight.
    • It was introduced by the RBI as a provision for banks to avail overnight funds during a revision of the country’s monetary policy in 2011-12.
    • It is usually higher than the repo rate.
    • Banks can use their SLR or statutory liquidity ratio to take loans under MSF.
      • This is a short-term loan used to maintain the liquidity of banks.

Source: IE

 
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