Repo Rate Increase: Consider the Impact Before Making Decisions

The RBI’s monetary policy committee (MPC) voted to raise the benchmark repo rate by 25 basis points at its most recent meeting, which was held just a few days after the Union budget. The MPC stated that measured action was required to break the persistence of core inflation. This unexpected increase in inflation is likely to complicate policy decisions for MPC members when they meet next in the first week of April.

What are these so-called basis points?

  • A basis point is a unit of measurement for interest rates, bond yields, and other financial indicators.
  • One basis point, or 0.01%, is one-hundredth of a percentage point.
  • For instance, if the Reserve Bank of India (RBI) raises the repo rate by 25 basis points, the interest rate rises by 0.25%.

What does it mean?

  • If the Reserve Bank of India (RBI) continues to raise the repo rate by basis points, it indicates that the central bank is tightening its monetary policy stance in order to manage the economy’s inflationary pressures.

Back2basics: Monetary Policy Committee (MPC)

  • The RBI’s policy-setting body. The Monetary Policy Committee (MPC) is an RBI committee tasked with setting the benchmark policy interest rate (repo rate) in order to keep inflation within the specified target level.
  • The RBI Act, 1934 was amended by the Finance Act (India), 2016 to establish the Monetary Policy Committee (MPC) to improve transparency and accountability in fixing India’s monetary policy.
  • Following discussion, the following policy is published: Following each meeting, the policy is published, with each member explaining his or her position.
  • Accountable to the GOI: If inflation exceeds the prescribed range for three consecutive months, the committee must report to the Government of India.

What exactly is inflation?

  • Inflation is defined as an increase in the price of goods and services purchased by households. The rate of change in those prices is used to calculate it.
  • Prices typically rise over time, but they can also fall (a situation called deflation).

The current trends of Inflation

  • Rise in retail inflation: Retail inflation, as measured by the consumer price index, rose to 6.52 per cent in January, up from 5.72 per cent in December, reversing the declining trend seen in the preceding months.
  • Food inflation drove much of the increase: the consumer food price index rose to 5.94%, up from 4.19 percent the previous month, driven primarily by cereals.
  • Price pressures persist throughout the economy: Clothing and footwear inflation, household goods and services inflation, personal care effects inflation, and education inflation remained elevated, indicating that price pressures remain fairly broad-based across the economy.

The Reserve Bank of India’s maximum tolerance for inflation

  • Maximum inflation that can be tolerated: The Reserve Bank of India’s (RBI) upper tolerance limit for inflation is the highest level of inflation that the RBI will tolerate before intervening to bring inflation back within its target range.
  • The RBI’s limit is defined in terms of Consumer Price Index (CPI) inflation, and the RBI has set an upper tolerance limit of 6%, a lower tolerance limit of 2%, and a central target of 4%. This means that the RBI intends to keep CPI inflation between 2-6%, with a target of 4%.
  • Inflation-controlling tools include: If inflation exceeds the upper tolerance limit of 6%, the RBI must take action to bring it back within the target range. To control inflation, the RBI employs a variety of monetary policy tools, including changing reserve requirements for banks and conducting open market operations to manage liquidity in the financial system.

@the end

Before taking further action, monetary policy experts Varma and Goyal recommend pausing to assess the impact of previous tightening. Despite a cumulative increase of 250 basis points, inflation is expected to remain above the 6% target. Before making any decisions, the full impact of previous tightening should be considered.

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