Explained: Why the RBI refused to cut interest rates

4 min read

News:The Monetary Policy Committee(MPC) of the Reserve Bank of India has decided to keep the repo rate unchanged at 5.15% in its fifth bi-monthly monetary policy statement.

Facts:

Issues before RBI:

  • The RBI’s most important mandate is to maintain price stability which means RBI is required by law to maintain retail inflation based on Consumer Price Index(CPI) at the 4% level (with a band of variation of 2 percentage points).
  • However,another key concern for the RBI is the overall economic growth in the economy.
  • Usually,retail inflation and economic growth tends to rise and fall at the same time because higher growth implies higher demand for goods and as such a spike in prices.
  • However, at the current juncture in the Indian economy,economic growth has decelerated sharply even as inflation has sped up.
  • Hence,the challenge before the RBI was to balance the concerns of boosting growth while making sure that inflation does not spiral out of control.

Reasons for not reducing the repo rate:

  • Firstly,the RBI is worried about the rise in inflation which is the primary issue that the RBI is mandated to control.
  • Secondly,the RBI has already cut repo rates by 135 bps.But only about 44 bps have been passed on to the consumers of new loans.Hence,the RBI believes that with more time, the monetary transmission will deepen.
  • Thirdly,the RBI has pointed towards the forthcoming Union Budget for fiscal efforts to boost growth.

RBI’s forecast for economic growth and inflation:

  • RBI has lowered its real GDP growth forecast for 2019-20 to 5% from 6.1%.
  • It has increased the CPI inflation projection to 5.1-4.7% for the second half of the current fiscal year and and 4.0-3.8% for the first half of the next fiscal year 2020-21.
  • However,it has said that the inflation is rising in the near-term but it is likely to moderate below target by the second half of 2020-21.

Additional information:

About Repo rate:

  • Repo stands for ‘Repurchasing Option’.It refers to the rate at which commercial banks borrow money from the RBI.It is one of the main tools of RBI to keep inflation under control.

About Monetary Policy Committee(MPC):

  • The Monetary Policy Committee(MPC) is a committee of the Reserve Bank of India.
  • The MPC is made up of six members with three nominated by the Union government and three representing the RBI.
  • The MPC is mandated by law to ensure that retail inflation stays within a band of two percentage points of the target inflation rate of 4%.