Repo Rate cut by Monetary Policy Committee

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By admin April 8, 2019 11:36

Repo Rate cut by Monetary Policy Committee

The policy repo rate was cut by 25 basis points (6.25% to 6%) by the Monetary Policy Committee (MPC) in the 1st week of April’2019. This was the second consecutive cut in the policy rate by the MPC this year.

 

A brief review of Repo Rate

Repo Rate stands for ‘Repurchase Option’, wherein the ‘repurchase’ refers to the rate at which the banks borrow money from the RBI by selling govt securities (G-Secs) with an agreement to repurchase back these G-Secs from RBI at a future date.

 

  • It is a money market instrument used to target inflation.
  • Plainly speaking, the RBI decreases the repo rate in order to inject money into the economy and increases the repo rate to suck out excess liquidity.
  • Further, a decrease in repo rate leads to easier borrowing by commercial banks which in turn generally leads to decreased rates for consumer loans.
  • On the contrary, an increase in the repo rate leads to lesser borrowings by the commercial banks and a consequently higher rate for consumer loans.

 

If the inflation is high, RBI tends to keep the repo rate high to suck out excess liquidity and hence, bring down the inflation. Similarly, it is a common practice to increase the repo rate only when inflation is under control.

 

Why have such aggressive cuts taken place in consecutive quarters?

  • There has been a decrease in the GDP forecasts to 7.2% from 7.4% for the current financial year. A decrease in repo rate can pump in more liquidity and hence boost the economy.
  • The Output Gap has remained negative (see below for explanation)
  • A slowdown in the investment and consumption demand in the economy
  • A decrease in the credit flows to the Industrial sector, particularly MSMEs
  • Concerns related to the Global Economic Recession which could adversely affect the Indian Economy
  • Besides, the rate of inflation (2.57%) has remained below the targeted 4% and hence, there is not much harm in decreasing the repo rate to boost economic growth.

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A review of the concept of ‘Output Gap’

The output gap refers to the difference between the actual output of the economy and its maximum potential. The output gap can be positive or negative :

 

  • A positive output gap, which results when actual output is above potential output, reflects excess demand in the economy which can generate inflationary pressures.

 

  • In contrast, a negative output gap – actual output being lower than potential output – occurs when the available resources in the economy are not fully utilised and reflects deficient demand).

 

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admin
By admin April 8, 2019 11:36