Reserve Bank of India (RBI) in its mid-quarter Monetary Policy Review, announced on 18 December 2013, has kept the policy rate unchanged at 7.75%. The move was unexpected in light of the recent spike in inflation, especially food inflation.
This has come as welcome relief for the industry which already is battling gloomy economic environment as indicated 1.8% growth in industrial output in November 2013.
The RBI’s policy decision to keep the policy rate unchanged is based on the assessment that there exists great deal of uncertainty with respect to the short-term path of inflation from its high current levels. Besides, given the weak state of the economy, RBI felt that it would be unwise to adopt an overtly reactive policy action. It would be more prudent to determine the lag-effect of monetary policy.
Thus, on the basis of an assessment of the current and evolving macroeconomic situation, the RBI decided to:
• Keep the policy Repo Rate under the Liquidity Adjustment Facility (LAF) unchanged at 7.75%, and
• Keep the Cash Reserve Ratio (CRR) of scheduled banks unchanged at 4.0% of the Net Demand and Time Liability (NDTL).
As a result, the reverse repo rate under the LAF will remain unchanged at 6.75%, and the Marginal Standing Facility (MSF) rate and the Bank Rate at 8.75%.
About Policy Rates
Basis points: It is the increase in interest rates in percentage terms. For instance, if the interest rate increases by 50 basis points (bsp), then it means that interest rate has been increase by 50%. One percentage point is broken down into 100 basis points. Therefore, an increase from 2% to 3% is an increase of one percentage point or 100 basis points.
Repo rate: Repo rate is the policy rate and is part of RBI’s Liquidity Adjustment Facility (LAF). It is the rate at which commercial banks borrow from the RBI by selling their securities or financial assets to the RBI for a short-period of time. It comes with an agreement that the sold securities will be repurchased by the commercial banks from the RBI at a future date at predetermined price. The repo rate is used by the central bank to increase liquidity in the system.
Reverse repo rate: Reverse Repo Rate is also a part of LAF. It is the rate of interest at which the central bank borrows funds from other banks for a short duration. The banks deposit their short term excess funds with the central bank and earn interest on it. This rate is used by the central bank to absorb liquidity from the economy. Generally it is one percentage less than the Repo rate.
Bank rate: The only way the bank rate is different from the repo rate is that the bank rate is the rate at which banks borrow money from the central bank without any sale of securities. It is generally for a longer period of time.
Cash reserve ratio: CRR is the minimum percentage of cash deposits that banks must keep with the central bank. The current rate is 4%, which means for a cash deposit of Rs. 100, the bank has to park 4 rupee with the central bank.
Marginal Standing Facility: The Reserve Bank of India in its monetary policy for 2011-12 introduced the marginal standing facility under which banks could borrow funds from RBI when there is a considerable shortfall of liquidity. This measure has been introduced by RBI to regulate short-term asset liability mismatches more effectively. Under this facility, banks can borrow up to 1% of their net demand.
Liquidity Adjustment Facility: Under this facility, banks borrow from the central bank by pledging government securities.
Statutory Liquidity Ratio: This is the percentage of deposits that banks must mandatorily hold in the form of government bonds. SLR bonds are liquid assets that can be sold at a short notice to meet any unexpected demand from depositors.
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