IASbaba’s Daily Current Affairs (Prelims + Mains Focus)- 7th June 2018
RBI MPC Policy Highlights and REPO RATE
Part of: GS Prelims and Mains Paper III – Indian Economy – Monetary Policy; RBI Reforms and its functions
- The six-member monetary policy committee (MPC) of the RBI increased the repo rate by 25 basis points to 6.25%.
- This is the first rate hike in four-and-a-half years; the last was in January 2014.
- Reasons for increase of repo rate – RBI raised rates after 4.5 years as crude price surges and due to inflation.
- Immediate effect – RBI lends money to commercial banks at higher rate and banks will raise their lending rates. Since, lending rates are high, people abstain from borrowing and consequently it leads to decrease in money supply in economy and decrease in inflation rate.
Do you know?
What is Repo rate?
- Repo rate is the rate at which the central bank of a country (RBI in case of India) lends money to commercial banks in the event of any shortfall of funds. Repo rate is used by monetary authorities to control inflation.
- RBI increases the repo rate during inflation and decreases it during deflation.
Important value additions:
Let’s see what happens when RBI increases and decreases Repo rate –
When RBI increases repo rate
- In order to control excess money supply and inflation in the economy, central bank increases repo rate and lends to commercial banks at a higher rate.
- Now, because of increased repo rate, funds come to commercial banks at a higher cost, so in order to cover those increased costs of acquiring funds, commercial banks increase their lending rates for loans and advances.
- Since, lending rates are increased, people abstain from borrowing and postpone their purchases thereby decreasing demand for products and services, consequently it leads to decrease in money supply in economy and decrease in inflation rate.
When RBI decreases repo rate:
- In order to cure depression and lack of effective demand, central bank decreases repo rates and lends to commercial banks at a reduced rate.
- Because of reduced rates, commercial banks can acquire funds at a lower cost and in order to acquire new consumers and markets they pass their benefit of lower cost to consumers by decreasing their prime lending rates on loans and advances.
- Since, lending rates are reduced by banks, credit is cheap and this induces people to venture in new business activities and purchase of capital goods leading to increased demand for capital goods and increased employment rates.