Repo Rate and its significance

- The Reserve Bank of India (RBI) Governor Shaktikanta Das announced that the monetary policy committee (MPC) has decided unanimously to keep the policy repo rate unchanged at 6.50 per cent.
  - MPC is a committee of the RBI which is entrusted with the task of fixing the benchmark policy interest rate (repo rate) to contain inflation within the specified target level.
  - Under the flexible inflation targeting (FIT) framework, the RBI targets to contain Consumer Price Index (CPI) based inflation within 4 percent with a tolerance band of (+/-) 2 percent for the period April 1, 2021, to March 31, 2026. (FIT is a monetary policy strategy used by the Central Bank to maintain the inflation level within a certain range)
  - The 2016 amendment of the Reserve Bank of India Act, 1934 provides for a statutory and institutionalised framework for the MPC.
  - The MPC has six members: RBI Governor (Chairperson), RBI Deputy Governor in charge of monetary policy, one official nominated by the RBI Board and remaining 3 members would represent the Government.

The MPC makes decisions based on majority vote. In case of a tie, the RBI governor will have a second or casting vote.

- The repo rate is one of several direct and indirect instruments that are used by the RBI for implementing monetary policy.

Monetary policy is a set of tools that a nation’s central bank has available to promote sustainable economic growth by controlling the overall supply of money that is available to the nation’s banks, its consumers, and its businesses.

- Specifically, the RBI defines the repo rate as the fixed interest rate at which it provides overnight liquidity to banks against the collateral of government and other approved securities under the liquidity adjustment facility (LAF).

LAF is a tool used in monetary policy, primarily by the RBI through which the central bank manages the liquidity needs of the commercial banking system.

The LAF has two legs – repo and the reverse repo. If repo provides (injects) liquidity into the banking system, reverse repo receives (absorbs) liquidity from the system. This arrangement is effective in managing liquidity pressures and assuring basic stability in the financial markets.

When banks have short-term requirements for funds, they can place government securities that they hold with the central bank and borrow money against these securities at the repo rate.
Since this is the rate of interest that the RBI charges commercial banks when it lends them money, it serves as a key benchmark for the lenders to in turn price the loans they offer to their borrowers.

Inflation can broadly be: mainly demand driven price gains, or a result of supply side factors that in turn push up the costs of inputs used by producers of goods and providers of services, thus spurring inflation, or most often caused by a combination of both demand and supply side pressures.

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