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In a surprise move that went against the street expectations of a 25-basis points rate hike, the RBI on Thursday kept the repo rate unchanged at 6.5% amid concerns over the global banking crisis. Where it pointed out that the core inflation- non-food, non-fuel component could stay elevated due to lagged pass through of input costs.
This decision to keep it fixed has been unanimously taken by all the 6 members of the monetary policy committee. As this has been a great news for many of the borrowers where still they can pay the amount which they are actually paying.
REASON OF THE PAUSE
The RBI underlined the risk from protracted geopolitical tensions, tight global financial condition and global financial market volatility to its monetary policy outlook.
“Global financial market volatility has surged, with potential upsides for imported inflation risks,” as we can relate it to global financial crisis such as-
NOTE- where the governor of the RBI defended the rate increases by stating that the RBI's goal is to maintain price stability and that real interest rates had just become positive after spending the previous three years in the negative region.
WHAT IS REPO RATE?
Repo ratealso known as the benchmark interest rate is the rate at which the RBI lends money to the banks for a short term. When the repo rate decreases, borrowing from RBI becomes cheaper. After the rate cut, EMIs on home loans and other loans will come down significantly.
The increased repo rate will discourage banks to borrow from the RBI and lending to the customers. This in turn will reduce the liquidity and demand in the market. It is part of the contractionary monetary policy.
On the other hand, decreased repo rate will encourage banks to borrow and lend to customers increasing the liquidity and demand in the market. This is a part of the Expansionary Monetary Policy.
WHAT IS NEGATIVE INTEREST RATE?
It refers to a scenario in which cash deposits incur a charge for storage at a bank, rather than receiving interest income. Instead of receiving money on deposits in the form of interest, depositors must pay regularly to keep their money with the bank.
Suppose inflation in the economy is going on 7% and where the interest rate being charged is 5% which is less than inflation so say that the interest rate is negative which is -2% as that is 7-5%= 2% which is not good for the economy.
As mentioned previously, the RBI raised repo rates, making loans more expensive and decreasing demand for loans from the general population as well as the value of loans as bank assets. Thus, there is a chance that the banks will fail.
However, in the real world, the RBI is keeping a close eye on the situation and has developed a stronger understanding that now is not the time to raise interest rates. For this reason, they have paused the process, which also acts as breathing room for loan recipients, giving them the advantage that they can still manage to take loans and giving banks the room to create assets.
CHALLENGES
That means if the US Federal Reserve raises interest rates, investors who have money invested in the Indian market will withdraw it and invest it in the US market instead, where they have a better chance of making more money. However, this will cause a ruckus in India because it will devalue the Indian rupee and lower the value of the country's currency and there will be shortage of dollar in the market.
WAY FORWARD
| PRELIMS | Definition- monetary policy and it’s instruments and their impact. |
| MAINS | Impact of monetary policy instruments, global impact on financial crisis and steps taken by India |
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