RBI keeps REPO RATE unchanged

Syllabus: Indian Economy

• •Source: IE*

Context: The Reserve Bank of India (RBI) has refrained from cutting the repo rate despite stable inflation rates. The repo rate, which influences loan EMIs, has remained unchanged since February 2023.

What is the Repo Rate and who maintains it?

The repo rate is the interest rate at which the RBI lends money to commercial banks. It impacts economic activity: a lower rate stimulates borrowing and spending, while a higher rate discourages it. The RBI’s monetary policy aims to maintain price stability, target a 4% inflation rate, and promote economic growth by adjusting the repo rate accordingly. Lowering the rate stimulates borrowing post-pandemic, while raising it curbs excessive spending during inflationary periods like the Russia-Ukraine conflict.

Other Tools for Controlling Interest rates

• Open Market Operations (OMO): The RBI buys or sells government securities to adjust money supply and interest rates.

• Cash Reserve Ratio (CRR): The percentage of deposits banks must hold with the RBI, influencing their lending capacity.

• Statutory Liquidity Ratio (SLR): The percentage of deposits banks must invest in government securities, also affecting liquidity and interest rates.

Reasons for Not Cutting Interest Rates:

Reasons | Description

1. 1.Sticky Inflation: | Despite a gradual decline, inflation hasn’t reached the 4% target since January 2021, hovering around 5% in the first four months of 2024.
2. 2.Commitment to Durable Inflation Targeting: | The RBI aims for sustained inflation around 4%, not just occasional dips below this level.
3. 3.Strong Economic Growth: | India’s GDP growth rate has been robust, with forecasts revised upwards to 7.2% for the current financial year, suggesting no urgent need for rate cuts to stimulate activity.
4. 4.Fiscal Deficit Concerns: | The RBI’s decision may be influenced by the forthcoming Union Budget and government borrowing plans, which could impact inflation or interest rates.

Understanding the Impact of High Interest Rates:

Positives:

• Taming Inflation: High rates discourage borrowing and spending, reducing the money supply and easing inflationary pressures.

• Financial Stability: Attract foreign investments, strengthening the rupee and foreign exchange reserves, boosting financial stability. E.g. India’s foreign exchange reserves surged past $600 billion in 2023 amidst high interest rates, providing a cushion against global uncertainties.

• E.g. India’s foreign exchange reserves surged past $600 billion in 2023 amidst high interest rates, providing a cushion against global uncertainties.

• Promoting Savings: Higher interest rates on deposits incentivize saving, increasing domestic capital availability for investment and growth. E.g. Fixed deposit rates above 7% in India have encouraged individuals to save more, leading to higher bank deposits.

• E.g. Fixed deposit rates above 7% in India have encouraged individuals to save more, leading to higher bank deposits.

• Curbing Asset Bubbles: Discourage excessive speculation in assets like real estate and stocks, promoting financial market stability. Example: High interest rates during 2010-11 helped cool down the overheating real estate market in India, preventing a potential bubble.

• Example: High interest rates during 2010-11 helped cool down the overheating real estate market in India, preventing a potential bubble.

• Encouraging Financial Discipline: High rates promote prudent borrowing and lending practices among businesses and individuals, reducing risk-taking and defaults.

Negatives:

• Slower Economic Growth: Expensive borrowing can dampen investment and consumer spending, potentially slowing economic growth. E.g. High interest rates during 2019-20 contributed to a slowdown in India’s GDP growth rate.

• E.g. High interest rates during 2019-20 contributed to a slowdown in India’s GDP growth rate.

• Increased Debt Burden: Existing borrowers face higher interest payments, straining finances and potentially leading to defaults.

• Impact on Investment: High rates can discourage investments in key sectors like infrastructure and manufacturing, hindering long-term growth.

• Pressure on Businesses: High borrowing costs can squeeze profit margins and hamper business expansion plans, potentially impacting job creation. E.g. Small and medium enterprises (SMEs) often face challenges in accessing credit at high interest rates.

• E.g. Small and medium enterprises (SMEs) often face challenges in accessing credit at high interest rates.

• Impact on Consumer Spending: High interest rates on credit cards and personal loans can reduce discretionary spending, impacting retail sales and overall consumption. E.g. High interest rates on auto loans have led to a slowdown in car sales in India.

• Currency Appreciation: High interest rates can attract foreign capital, leading to currency appreciation, which can hurt export competitiveness. E.g. The Indian rupee’s appreciation in 2023 due to high interest rates posed challenges for export-oriented sectors like textiles and IT.

Conclusion

The RBI’s decision to maintain high interest rates reflects its efforts to balance inflation control with growth considerations. It will continue to monitor economic data and adjust rates as needed to achieve a harmonious outcome for the Indian economy.

Other steps announced by RBI in this MPC Meeting:

• Rationalization of Export and Import regulations under the Foreign Exchange Management Act (1999) to boost ease of doing business.

• Establishment of a Digital Payments Intelligence Platform (DPIP) using advanced technology to combat payment fraud.

• Formation of a committee chaired by A.P. Hota to explore setting up a digital public infrastructure for DPIP.

• Integration of UPI Lite into the e-mandate framework with an auto-replenishment feature for the UPI Lite wallet.

• Revision of bulk deposit definition to include Single Rupee term deposits of ₹3 crore and above for Scheduled Commercial Banks (excluding Regional Rural Banks(RRBs)) and Small Finance Banks. For Local Area Banks, the threshold is ₹1 crore and above as applicable for RRBs.

About MPC:

The Monetary Policy Committee (MPC), established under the amended RBI Act of 1934, comprises six members: three from the RBI and three appointed by the government. It decides the policy repo rate aimed at meeting the inflation target. Each member holds one vote, with the Governor having a casting vote in case of a tie.

Insta Links:

• Variable Rate Repo (VRR)

• What is the RBI’s MPC?

Mains Link:

Do you agree with the view that steady GDP growth and low inflation have left the Indian economy in good shape? Give reasons in support of your arguments. (UPSC 2019)

Prelims Link:

Which of the following statements is/are correct regarding the Monetary Policy Committee (MPC)? (UPSC 2017)

• It decides the RBI’s benchmark interest rates.

• It is a 12-member body including the Governor of RBI and is reconstituted every year.

• It functions under the chairmanship of the Union Finance Minister.

Select the correct answer using the code given below:

(a) 1 only (b) 1 and 2 only (c) 3 only (d) 2 and 3 only

Ans: (a)

• If the RBI decides to adopt an expansionist monetary policy, which of the following would it not do? (UPSC 2020)

• Cut and optimize the Statutory Liquidity Ratio

• Increase the Marginal Standing Facility Rate

• Cut the Bank Rate and Repo Rate

Select the correct answer using the code given below:

(a) 1 and 2 only (b) 2 only (c) 1 and 3 only (d) 1, 2 and 3

Ans: (b)