RBI Monetary Policy: Key takeaways and its impact on your pocket

The Reserve Bank of India (RBI) kept the policy repo rate unchanged at 4% while maintaining its accommodative stance after the conclusion of the Monetary Policy Committee (MPC) meeting today, 6 August 2021. This means that your EMIs (equated monthly instalments) will not go down but the good part it will neither go up.

The RBI has primary objectives of controlling inflation and aid growth in the economy uses several tools to achieve this objective.

The repo rate, reverse repo rate, cash reserve ratio (CRR) and marginal standing facility (MSF) are some of the tools.

Repo Rate

When we need money and run out of savings, we take loans from banks. Banks in turn charge a certain interest rate on these loans from us. This is called as cost of credit (the rate at which we borrow the money).

Similarly, when banks are in need of money, they approach the RBI. The rate at which banks borrow money from the RBI is known as “Repo Rate”. Repo rate is a short form of Repurchase Rate. Generally, these loans are for short durations up to two weeks.

Repo Rate is used by the RBI essentially to control credit availability, inflation, and economic growth.

Repo Rate is a significant rate for you too. As everything from interest rates on loans to returns on deposits is influenced by this crucial rate set by the RBI, which is why interest rates on home loans, car loans and other kinds of borrowings go up and down based on the direction of Repo Rate change.

Similarly, banks adjust savings account, fixed deposit returns based on this benchmark rate.

So, whenever the repo rate is cut, can you expect both the deposit rates and lending rates of banks to come down too?

This may or may not happen every time as the repo rate cut does not get automatically transmitted to the individual bank customers. The lending rate of banks goes down to the existing bank borrowers only when the banks pass on such cuts to the customers.

In the current scenario, the repo rate is at 4%, and the reverse repo rate is 3.35%. The RBI had last revised its policy rate on May 22, 2020, in an off-policy cycle to perk up demand by cutting the interest rate to a historic low of 4%. Since then, it has maintained the status quo.

Reverse Repo Rate

Reverse Repo Rate is the exact opposite of Repo Rate. Here RBI borrows money at this rate from the banks for the short term. In other words, the banks park their excess funds with the central bank at this rate. When banks have surplus funds but have no lending (or) investment options, they deposit such funds with RBI to earn interest on such funds.

The Reverse Repo Rate is at 3.35%

Cash Reserve Ratio

Another effective tool that RBI uses to manage liquidity in the economy is CRR (cash reserve ratio) is the amount of funds that banks have to maintain with the RBI. The objective of the CRR is to ensure that the banks maintain a minimum level of liquidity against their liabilities so that they don’t run short of liquidity in case of excess demand for funds and these have to be maintained with the RBI on a daily basis.

The RBI uses the CRR to drain out excessive money from the system.

The RBI cuts CRR when it wants to increase the liquidity in the banking system and boost credit. A cut in CRR is also profitable for banks because they can now convert their idle non-income bearing deposits into income-earning assets.

If the central bank decides to increase the CRR, the amount available with the banks goes down thereby reducing their lending capacity. The RBI does that to remove excess liquidity in the system.

The RBI kept CRR unchanged at 4%. However, to neutralize the impact CRR restoration RBI redemption of government securities worth around Rs 52,000 crore during the last week of May.

Marginal Standing Facility (MSF)

Marginal standing facility (MSF) is a window for banks to borrow from the Reserve Bank of India in an emergency situation like the one in which we are right now. RBI has introduced this borrowing scheme to regulate short-term asset-liability mismatch in a more effective manner.

Both repo rate and MSF are rates at which RBI lends money to various other banks. However, Repo rates are short term financial loans whereas MSF for overnight lending.

RBI has left this rate also unchanged at 4.25%.

Inflation & GDP projections

As a part of monetary policy, RBI announces its projection on inflation & GDP growth. The RBI has increased the retail inflation estimate for the financial year 2021-22 to 5.7 per cent from 5.1 per cent projected earlier while retained the GDP growth target for the financial year at 9.5 per cent.

Price pressures have stayed high in recent months. The closely tracked Consumer Price Index-based inflation (CPI) for the month of June rose 6.26 per cent, as food prices hardened further, and transportation costs rose due to higher petrol and diesel prices. The June print came slightly lower than 6.30 per cent for May, which was the highest in six months but continues to be above the MPC’s comfort zone of 2-6 per cent.

Das said while the recent inflationary trend has evoked concerns, this is more transitory in nature. Das emphasised that the conduct of MPC has been geared to rejuvenate growth. “Continued policy support is required to nurture a nascent economic recovery,” Das said, adding, any pre-emptive monetary policy measures may have an impact on the recovery. While inflation may remain high, the pressure should ease by the third quarter, Das said.

Overall, the tone of the monetary policy remains growth supportive. Higher inflation means that your monthly household expenses are likely to increase in the near term.