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Context
- Recently, the Reserve Bank of India (RBI) unveiled its latest bi-monthly monetary policy review.
- For the eighth consecutive time, the RBI decided not to change the benchmark policy rate, also called the repo rate.
Understanding Repo Rate
- Definition: The repo rate is the interest rate at which the RBI lends money to commercial banks.
- Economic Incentives:
- Reducing Repo Rate: When the RBI wants to incentivize economic activity, it reduces the repo rate, making it cheaper for banks to borrow and lend money.
- Increasing Repo Rate: When the RBI wants to disincentivize economic activity, it raises the repo rate, making borrowing more expensive.
- Impact on EMIs: Movements in the repo rate significantly impact the EMIs for car, home, or business loans.
MORE ON REPO RATE, INFLATION AND MONETARY POLICY: https://www.iasgyan.in/daily-current-affairs/repo-rate#:~:text=THE%20RECENT%20SUDDEN%20RISE%20IN,the%20Bank%20Rate%20to%206.15%25.
INFLATION: https://www.iasgyan.in/daily-current-affairs/inflation-19#:~:text=Inflation%20measures%20the%20average%20price,items%20is%20called%20'deflation.
Goals of RBI's Monetary Policy
Primary Goal: Price Stability
- Objective: To maintain price stability in the economy, ensuring prices do not fluctuate beyond a reasonable degree.
- Measurement: This is measured by the retail inflation rate — the rate of price rise faced by the average individual consumer.
- Inflation Target: By law, the RBI targets an inflation rate of 4%, which is considered the optimal level to incentivize production without significantly disincentivizing consumers.
Secondary Goal: Economic Growth
- Promoting Growth: The RBI promotes economic growth by adjusting the repo rate to facilitate borrowing and spending.
- Boosting Activity: In situations like the post-Covid recovery, the RBI cuts the repo rate to make borrowing easier.
- Controlling Inflation: When inflation exceeds the 4% target, such as after the Russia-Ukraine war, the RBI raises the repo rate to reduce demand for credit-fueled consumption.
- Savings Incentives: Higher repo rates also make it more attractive to keep money in the bank rather than spending it.
Reasons for RBI's Decision Not to Cut Interest Rates
Gradual Decline in Retail Inflation
- Despite the RBI maintaining a consistently high repo rate, retail inflation, measured by the rate of price rise faced by consumers, hasn't fallen to the desired 4% mark since January 2021.
- While there has been a decline, it's been slow and concerns persist about the persistence of inflation. For instance, in the first four months of 2024, inflation rates have hovered around 5%.
- The RBI is cautious about reducing rates without solid evidence that inflation will stay around 4% sustainably.
Commitment to Sustainable Inflation Alignment
- The RBI doesn't rush to cut the repo rate when inflation briefly falls to or below 4% in any one month. Governor Shaktikanta Das emphasizes the need for a durable alignment of inflation to the 4% target.
- The central bank wants assurance that the inflation rate will remain consistently around the 4% mark before considering rate cuts.
Strong GDP Growth Rate
- India's GDP growth rate has remained robust, contrary to expectations that rate cuts would stimulate economic activity.
- The RBI has revised the GDP forecast for the current financial year upwards, indicating expectations for a fourth consecutive year of over 7% growth.
- Given this strong growth trajectory, the RBI may feel that further rate cuts are unnecessary to bolster economic expansion.
Considerations Regarding the Union Budget
- The RBI's decision may also be influenced by factors such as the forthcoming Union Budget.
- There's anticipation among economists regarding how political dynamics within a coalition government could impact the Centre's commitment to fiscal deficit.
- Higher than expected fiscal deficit could have implications for both inflation (if more money is injected into the economy) and interest rates (if there's reduced availability of funds for private sector borrowing).
In summary, the RBI's decision not to cut interest rates reflects a cautious approach driven by concerns about inflation stability, the need for sustainable economic growth, and considerations surrounding fiscal policy dynamics.
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PRACTICE QUESTION
Q. Critically analyze the role of the Reserve Bank of India (RBI) in formulating and implementing monetary policy. How effective has the RBI been in achieving its objectives of price stability, economic growth, and financial stability in recent years?
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