Hike in RBI Repo Rate and its Impacts

Context: The final meeting of the Monetary Policy Committee (MPC) for the financial year 2022-23 has concluded recently.

Key Outcome of the Meeting

• Repo Rate: The repo rate has increased by a cumulative 250 basis points (a basis point is one-hundredth of one percentage point) to 6.50 per cent since May 2022.
• Marginal Standing Facility (MSF): The MSF rate will stand revised at 6.75%.
• Standing deposit facility (SDF): SDF rate stands adjusted to 6%.

Monetary Policy Committee

• It is a statutory and institutionalized framework under the Reserve Bank of India Act, 1934, for maintaining price stability, while keeping in mind the objective of growth.
• The Governor of RBI is the ex-officio Chairman of the committee.
• The MPC determines the policy interest rate (repo rate) required to achieve the inflation target (4%).
• It was set up on the recommendations of the Urjit Patel committee in 2014.

Key Forecasts

• Growth projection
  • The RBI has projected GDP growth for the next fiscal (FY2024) at 6.4 per cent.
  • The MPC had slashed the GDP forecast for fiscal 2023 to 6.8 per cent from 7 earlier due to protracted geopolitical tensions, global slowdown and tightening of global financial conditions.
• Inflation forecast
  • The central bank has lowered the inflation target for FY23 from 6.7 per cent to 6.5 per cent – which is still above the RBI’s target level of 4 per cent.
  • Inflation is expected to be 5.3 per cent in FY24.

Possible Impacts of Increase in the Repo Rate

• Higher borrowing costs: An increase in repo rate can lead to higher interest rates on loans for consumers and businesses, making borrowing more expensive.
• Reduced borrowing: The higher cost of borrowing can reduce the demand for loans, leading to a decrease in borrowing and spending, which can slow down economic growth.
• Stronger currency: Higher interest rates can attract foreign investment, strengthening the local currency.
• Decreased inflation: Higher repo rates can curb inflation by making borrowing more expensive and reducing spending, which can help keep prices stable.
• Reduced economic growth: Higher interest rates can slow down economic growth by reducing the amount of money available for borrowing and spending.

Key Terms

• Policy Repo Rate:
  • Repo rate is the rate at which the central bank of a country lends money to commercial banks in the event of any shortfall of funds by purchasing the security.
• Standing Deposit Facility (SDF):
  • The SDF is a liquidity window through which the RBI will give banks an option to park excess liquidity with it.
  • It is different from the reverse repo facility in that it does not require banks to provide collateral while parking funds.
• Marginal Standing Facility Rate:
  • MSF is a window for scheduled banks to borrow overnight from the RBI in an emergency situation when interbank liquidity dries up completely.
  • Under interbank lending, banks lend funds to one another for a specified term.
• Bank Rate:
  • It is the rate charged by the RBI for lending funds to commercial banks without collateral.
• CRR:
  • Under CRR (Cash Reserve Ratio), commercial banks have to hold a certain minimum amount of deposit (NDTL) as reserves with the central bank.
• SLR:
  • Statutory Liquidity Ratio or SLR is the minimum percentage of deposits that a commercial bank has to maintain in the form of liquid cash, gold or other securities.

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