Definition of key monetary policy instruments
- Repo rate is the rate at which RBI lends money to commercial banks in the event of any shortfall of funds. It is the key instrument of monetary policy to control inflation.
- Reverse Repo is the rate at which banks purchase government securities from RBI to lend it money and earn interest.
- MSF is an emergency borrowing (during cash shortage) by banks from RBI.
Repo rate to control inflation and boost growth
- In the event of inflation, central banks increase repo rate as this acts as a disincentive for banks to borrow from the central bank.
- This ultimately reduces the money supply in the economy and thus helps in arresting inflation.
- Decreasing the repo rates will have an opposite effect and increase the money-supply in the economy. More money means more spending, demand, investment and growth.
What is Monetary Policy?
- The monetary authority, typically the central bank of a country, is vested with the responsibility of framing the monetary policy.
- Monetary policy refers to the use of instruments under the control of the central bank to regulate the availability, cost and use of money and credit.
- It aims at setting the policy (repo) rate based on assessment of inflation, growth and other macroeconomic risks.
Instruments of Monetary policy
Policy Repo rate, Reverse repo rate, Bank rate, Marginal Standing Facility Rate, and Reserve ratios - Cash Reserve Ration (CRR) and Statutory Liquidity Ratio (SLR) are some of the tools used by RBI in the implementation of monetary policy.
RBI cuts repo rate by 50 basis points
- In a surprising move, RBI cut its key repo rate by 50 basis points (bps) to 6.75%.
- This was a much needed step for boosting growth and investment demand.
- Talking about the rate cut, the fourth since January, RBI governor Raghuram Rajan said, "Banks should be able to pass on the entire rate cut of 1.25% this year to borrowers over time"
Favorable conditions for rate cut
- The developments on inflation front, US Federal Reserve rate policy, etc. have provided favorable conditions for Raghuram Rajan to lower the policy rates.
- Since the last policy in August, consumer price inflation eased to a record low of 3.66% in August 2015 from 3.78% in July 2015.
- The US Federal reserve rates too remained unchanged at near-zero levels as of 17 September.
Jaitley welcomes rate cut by RBI
- Finance Minister Arun Jaitley welcomed the RBI's decision to cut the repo rate, saying it will help in the recovery of the economy.
- He said it would provide policy support and added that the government was committed to meeting its fiscal deficit targets.
- Jaitley also said, "RBI rate cut actually implies that inflation has moderated significantly and is now in the comfort zone."
RBI maintains status quo on policy rates
- After giving a pleasant surprise of 0.5% reduction in Sept'15 bimonthly policy review, RBI had kept the policy rates unchanged in its 5th bimonthly review.
- This was widely expected by economists as RBI had already lowered policy rate by 1.25% in the year.
- Commercial banks, on the other hand, had not cut the rates commensurately and median base lending rates had declined by 0.6%.
What are base lending rates?
Base lending rates are the lowest rate at which the banks can lend except to a few sections such as weaker sections. Base rate which is applicable for all loans had not declined commensurately because rising NPAs are forcing banks to increase margins.
RBI keeps policy rates unchanged
- In its first bimonthly monetary policy review of the year, RBI has kept the policy rates and reserve ratios unchanged.
- The repo rate stands at 6.75%, while CRR at 4% and SLR at 21.5%.
- RBI governor, Raghuram Rajan has said that he would wait for the Union budget and more inflation data before being "accommodative".
- As expected, markets and rupee have reacted negatively.
RBI cuts repo rate by 0.25%
- RBI has reduced the repo rates to 6.5%, a 0.25% cut against the expected 0.5%.
- The reverse repo rate has been hiked by 0.5% to 6%.
- While the CRR has been kept unchanged at 4%, MSF has been trimmed by 0.75% to 7%.
- RBI expects the economy to grow by 7.6% in the FY2016-17 and has kept the inflation target at 5% for FY2016-17.
Markets react negatively
- "Rate cut is sensible, given the current state of the economy", RBI governor Raghuram Rajan said without ruling out the possibility for another rate cut later this year.
- Notably, the rates are at a 5-year low.
- Markets were expecting a deeper cut of 0.5% and have reacted negatively to the less than expected rate cut.
- Both the Sensex and Nifty are trading in red.