Repo Rate Kept Unchanged

Source-This post on Repo Rate Kept Unchanged has been created based on the article “Sticky inflation: Why is RBI refusing to cut interest rates?” published in “The Indian Express” on 8 June 2024.

UPSC Syllabus-GS Paper-3– Indian Economy and issues relating to Planning, Mobilization of Resources, Growth, Development and Employment.

Context-The article discusses reasons behind the Reserve Bank of India’s (RBI) decision to keep the benchmark repo rate unchanged for the eighth consecutive time during its latest bi-monthly monetary policy review.

What is a Repo Rate?

Definition-The repo rate is the interest rate at which the RBI lends money to commercial banks.

Impact-A) A lower repo rate incentivizes economic activity by making it cheaper for banks to borrow from the RBI and lend to customers.

B) A higher repo rate disincentivizes economic activity by making it costlier for everyone in the economy to borrow money. Movements in the repo rate have a significant impact on the EMIs (Equated Monthly Installments) paid for car, home, or business loans.

What is the goal of RBI’s monetary policy?

1) Price Stability-The primary goal of RBI’s monetary policy is to maintain price stability in the economy by targeting an inflation rate of 4%. This goal is mandated by the law.

2) Promote Economic Growth-When the economy needs a lift, such as after the COVID pandemic, the RBI lowers the repo rate. This makes borrowing money easier for both consumers and producers, encouraging spending.
Conversely, when inflation rises significantly above 4%, like during the Russia-Ukraine conflict, the RBI raises the repo rate to lessen the demand for borrowing money, thus reducing excessive spending fueled by credit.

Read more- Monetary Policy – Basics Simplified

What are the reasons for not cutting interest rates?

Despite the retail inflation rate coming closer to the 4% target and staying within the RBI’s comfort zone of 2-6% since September 2023, the RBI has not changed the repo rate since February 2023. The reasons for this are:

1) Sticky Inflation- While the inflation rate has dropped, it hasn’t reached 4% since January 2021, and the decline has been slow. The RBI is concerned about this persistent inflation, which stayed around 5% in the first four months of 2024.

2) Commitment to Durable Inflation Targeting– The RBI wants to keep inflation around 4% consistently and doesn’t reduce rates immediately when inflation falls below this target for just one month. The RBI believes that any future drop in inflation below 4% will only be temporary.

3) Strong Economic Growth– India’s GDP growth rate has been unexpectedly strong recently, leading the RBI to raise its forecast for the current financial year from 7% to 7.2%. With this strong economic growth, it’s unlikely that the repo rate is hindering India’s economic activity.

4) Fiscal Deficit Concerns- The RBI’s choice might be affected by the upcoming Union Budget and how much the government plans to borrow from the market. This borrowing could impact inflation or interest rates.

Question for practice

What is the goal of RBI’s monetary policy? What are the reasons for not cutting interest rates?