The Monetary Policy Committee meeting of the Reserve Bank of India, which began on Monday, will announce its decision on Wednesday amid predictions about the repo rate to hike by 25 basis points (bps).
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Here are some important terms of the RBI’s monetary policy review meet:
What is monetary policy?
RBI’s monetary policy is a collection of financial tools and measures to safeguard and promote economic growth. According to the RBI, it conducts monetary policy with the “primary objective of maintaining price stability while keeping in mind the objective of growth.”
Monetary policy reviews are among the most effective tools of the central bank of any country to achieve financial stability and economic growth. Monetary policies basically control the overall supply of money available to commercial banks and, indirectly, to individual users and companies.
What is repo rate?
It is the interest rate charged by the RBI when commercial banks borrow by selling their securities to the central bank. Basically, it is the interest charged by the RBI when banks borrow from it - much like commercial banks charge you interest for a car loan or home loan. The current repo rate is 6.25%.
What is reverse repo rate?
It is the opposite of the repo rate. It is the interest RBI pays commercial banks when they store excess cash reserves. This is used by the RBI to control the flow of cash in the economy.
This allows the RBI to 'mop up' excess cash by making it more profitable for commercial banks to store cash reserves with the central bank. At present, the reverse repo rate is fixed at 3.35%.
Why is repo rate usually higher than reverse repo rate?
For the RBI to earn more than it pays, the repo rate is higher than the reverse repo rate. This results in RBI charging more interest rate from the banks on loans than it pays them on savings.
What is the impact of changes in the repo and reverse repo rates?
The RBI uses repo and the reverse repo rates to gently nudge interest rates offered throughout the banking sector and, therefore, the broader economy.
For example, if the RBI reduces the repo rate, it can encourage economic activity as it allows commercial banks to reduce the interest rate of loans for businesses, cars, homes, etc., as well as savings interest rates.
This encourages people to spend money because they see lesser value in keeping cash in the banks.
Reverse repo does the opposite - by incentivising commercial banks to store their reserves the RBI 'mops up' cash and increases interest rates for you. This encourages people to store rather than spend, reduces the amount of cash in circulation and, thereby, also controls inflation.