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Question
“With an objective to reduce inflation, Reserve Bank of India may promote the commercial banks to park their surplus funds with it.”
Discuss the rationale behind the step taken by the Reserve Bank of India.
Solution
Reverse repo rate is the rate at which commercial banks may park their surplus funds with the Central Bank.
In order to decrease inflation in an economy, Reserve Bank of India (RBI) may increase the reverse repo rate. With the increase in reverse repo rate, it becomes lucrative for commercial banks to park surplus funds with the central bank.
Consequently, this may lead to reduction in their lending capacity. Thereby, fall in the Aggregate Demand curbs the level of inflation.
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Read the following text carefully. Answer the given questions on the basis of the same and common understanding:
| On 30th September 2022, the Reserve Bank of India (RBI) raised Repo Rate for the fourth time in a row. The Monetary Policy Committee (MPC) decided to raise the policy rate by 50 basis points `(1 "basis point" =1/100 "th of a percent")`. After this announcement, the new repo rate stands at 5.9%, while the reverse repo rate continues to stand at 3.35%. Commercial banks borrow money from the Central Bank, when there is a shortage of funds. With the surge in the repo rate, borrowings by general public will become costlier. This is because, as RBI hikes its repo rate, it becomes costly for the banks to borrow short term funds from the Central Bank.
As a result, the banks hike the rates at which customers borrow money from them to compensate for the hike in the repo rate. This happens because banks offer loans to retail consumers at an interest rate which is generally, directly proportional to the repo rate. The increase of 0.50 percent in repo rate will lead. to a higher interest rates on loans for borrowers, implying that the Equated Monthly Instalments (EMIS) for repaying the existing loans will also increase. |
- Differentiate between repo rate and reverse repo rate.
- Outline and discuss the measure taken by the Monetary Policy Committee of Reserve Bank of India to control inflation.
As per the following news published in ‘The Hindu’ on 6th August, 2022:
'The Monetary Policy Committee (MPC) of the Reserve Bank of India raised the Repo Rate by 50 basis points.'
Identify and explain the likely cause and consequences behind this type of action taken by the Reserve Bank of India.
Discuss briefly, how this instrument helps in controlling credit, creation by commercial banks.
