The Monetary Policy Committee (MPC) of Reserve Bank of India (RBI) voted unanimously to leave the repo rate unchanged at 4 per cent. Consequently, the reverse repo rate also remains unchanged at 3.35 per cent. RBI had to reduce the repo rate, to its current levels, in May 2020 for infusing liquidity in the Indian economy. The pre-COVID-19 repo rate was 5.15 per cent. The first tranche of monetary easing was announced within days of the lockdown.
Repo and reserve repo rates are effective tools for absorbing and infusing money in the economy. Repo rate is the rate at which commercial banks borrow funds from the RBI by keeping Government securities as collateral. Commercial banks park their surplus funds with RBI and earn interest at the prevailing reverse repo rate.
When the economy is experiencing inflation, repo rate is increased to discourage banks from borrowing. When banks have fewer funds to lend and their marginal cost of raising fresh funds from the RBI increases, banks shift the burden of increased cost to borrowers. Reverse repo moves in the same direction of repo rate. RBI, being the central bank, lends money at a higher rate and pays lower rate for funds parked by commercial banks. The course of action taken by RBI during a recession is completely opposite to the one taken during inflation.
The direct impact of any modification in monetary policy rates can be seen in almost all sectors of the economy. Real estate and manufacturing sectors are instantly influenced by any action from RBI. Interest outlay of new projects, repurchase and term finance gets tweaked appropriately. There is a cyclical nature of the economy and the times of easy money don’t last too long. Timing the policy rate is not everyone’s cup of tea, but a little bit of insight about the nuts and bolts of economy helps in staying ahead of the curve.
Rationale for Maintaining Status-Quo
For the first time during the COVID-19 period, inflation has eased below the upper tolerance level of 6 per cent. The preliminary estimate of GDP for 2020-21 released by the National Statistical Office (NSO) on January 7, 2021 has turned out to be very close to the MPC’s December projection. The vaccination drive has begun in India and the number of active cases of COVID-19 are coming down rapidly. During this time of renewed economic activity, the accommodative stance maintained by RBI will foster growth. Though, the annual GDP for 2020-21 will contract, a strong recovery is projected for the next two financial years.
The RBI’s survey points towards improvement in capacity utilisation in the manufacturing sector to 63.3 per cent in Q2:2020-21 from 47.3 per cent in the preceding quarter. Moreover, the vaccination drive is expected to provide an impetus for the restoration of contact intensive sectors. The union budget for 2021-22 has focused on sectors such as health and well-being, infrastructure, innovation and research, among others.
The MPC statement had a word of caution for core inflation. The outlook for core inflation is influenced by the escalation in cost-push pressures seen in recent months. Petroleum product prices have reached historic highs as international crude prices surged in recent months and the high indirect taxes remain, both in the Centre and States. These, along with the sharp increase in industrial raw material prices have resulted in a broad-based increase in prices of services and manufacturing products in recent months. RBI urged for concerted policy action by both Centre and States, to ensure that the ongoing cost build-up does not escalate further.