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Take a look at the essential concepts, terms, quotes, or phenomena every day and brush up your knowledge. Here’s your knowledge nugget for today.
(Relevance: The change in RBI policy impacts most segments of the economy. UPSC has frequently asked questions on various instruments used by the RBI. In 2017, UPSC asked a direct question on the MPC. In this regard, it is important for an aspirant to understand the MPC, its role, and the various instruments used in monetary policy.)
The Monetary Policy Committee, headed by RBI Governor Sanjay Malhotra, announced on 7th February 2025 a reduction in the repo rate by 25 basis points to 6.25 per cent, after keeping it unchanged for two years. This is the first rate cut initiated by the RBI in five years, the last one being in May 2020. Until now, the repo rate stood at 6.5 per cent. The move comes barely a week after the Centre cut personal income tax to boost consumption.
1. Under Section 45ZB of the amended RBI Act, 1934, the central government is empowered to constitute a six-member Monetary Policy Committee (MPC) to determine the policy interest rate required to achieve the inflation target. The first such MPC was constituted on September 29, 2016.
2. Section 45ZB lays down that “the Monetary Policy Committee shall determine the Policy Rate required to achieve the inflation target”, and that “the decision of the Monetary Policy Committee shall be binding on the Bank”.
3. Section 45ZB says the MPC shall consist of the RBI Governor as its ex officio chairperson, the Deputy Governor in charge of monetary policy, an officer of the Bank to be nominated by the Central Board and three persons to be appointed by the central government. The last category of appointments must be from “persons of ability, integrity, and standing, having knowledge and experience in the field of economics or banking or finance or monetary policy”. (Section 45ZC)
Each member of the MPC has one vote, and in the event of an equality of votes, the Governor has a second or casting vote.
4. In May 2016, the RBI Act was amended to provide a legislative mandate to the central bank to operate the country’s monetary policy framework. The framework, according to the Reserve Bank of India website, “aims at setting the policy (repo) rate based on an assessment of the current and evolving macroeconomic situation; and modulation of liquidity conditions to anchor money market rates at or around the repo rate.”
5. The MPC fixes the benchmark interest rate — or the base or reference rate that is used to set other interest rates — in India. The primary objective of the RBI’s monetary policy is to maintain price stability while keeping in mind the objective of growth. Price stability is a necessary precondition to sustainable growth.
The RBI uses several direct and indirect instruments to maintain price stability while keeping the objective of growth. The instruments are Cash Reserve ratio (CRR), Repo rate, reverse repo rate, Statutory Liquidity Ratio (SLR), Standing Deposit Facility (SDF) Rate, Bank rate, and Liquidity Adjustment Facility (LAF).
📍The CRR is the percentage of a bank’s total deposits that is required to maintain in liquid cash with the RBI as a reserve. The CRR percentage is determined by the RBI from time to time. Today (6th December) RBI slashed the cash reserve ratio (CRR) by 50 basis points (bps) to 4 per cent from 4.5 per cent in a bid to boost liquidity in the financial system. The decision to cut CRR by 50 bps will free up Rs 1.16 lakh crore to the banking system, augmenting the lendable resources of banks.
📍The interest rate that the RBI charges when commercial banks borrow money from it is called the repo rate. It is used by the banks to meet their short-term funding needs. RBI has kept the Repo rate unchanged at 6.5% in a majority 4-2 decision. With the RBI leaving the Repo rate steady at 6.5%, all external benchmark lending rates (EBLR) linked to the Repo rate will not increase, giving relief to borrowers as their equated monthly instalments (EMIs) will not increase.
📍 The interest rate that the RBI pays commercial banks when they park their excess cash with the central bank is called the reverse repo rate. Since RBI is also a bank and has to earn more than it pays, the repo rate is higher than the reverse repo rate.
📍Statutory Liquidity Ratio (SLR) is the minimum percentage of deposits that commercial banks have to mandatorily maintain in the form of liquid cash government and state government securities.
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