CRR and Repo Rate

  • IASbaba
  • May 5, 2022
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In News: RBI raised key policy rates to fight inflation

  • RBI raised the repo rate by 40 basis points and CRR by 50 basis points

What is inflation?

  • Inflation refers to the rise in the prices of most goods and services of daily or common use, such as food, clothing, housing, recreation, transport, consumer staples, etc.

Types of Inflation

1) Demand-Pull Inflation

  • This type of inflation is caused due to an increase in aggregate demand in the economy.

Causes of Demand-Pull Inflation:

  • A growing economy or increase in the supply of money – When consumers feel confident, they spend more and take on more debt.
  • Deficit financing by the government, Increased borrowing etc causes demand pull inflation

2) Cost-Push Inflation

  • This type of inflation is caused due to various reasons such as:
  • Increase in price of inputs, hoarding and Speculation of commodities, defective Supply chain, increase in indirect taxes, depreciation of Currency, crude oil price fluctuation, defective food supply chain, interest rates increased by RBI etc
  • Cost pull inflation is considered bad among the two types of inflation. Because the National Income is reduced along with the reduction in supply in the Cost-push type of inflation
  • Indices used to measure inflation are Wholesale Price Index (WPI) and Consumer Price Index (CPI)
  • RBI is mandated by the Government of India under the Reserve Bank of India Act, 1924 to maintain the inflation target of 4%, with a tolerance band of +/- 2 percentage points
  • Thus RBI Monetary Policy tools to control inflation

Monetary Policy Measures

  • Monetary policy refers to the policy of the central Bank with regard to use of monetary instruments under its control to manage money supply and interest rates.
  • In 2016, the Reserve Bank of India (RBI) Act, 1934 was amended to provide a statutory basis for the implementation of the flexible inflation targeting framework.
  • Under amended RBI Act, 1934, the central government is empowered to constitute a six-member Monetary Policy Committee (MPC).
  • Composition: the MPC shall consist of 6 members:
  • RBI Governor as its ex officio chairperson,
  • Deputy Governor in charge of monetary policy,
  • An officer of the Bank to be nominated by the Central Board,
  • Three persons to be appointed by the central government
Tools Features
Cash Reserve Ratio (CRR) The average daily balance that a bank is required to maintain with the Reserve Bank as a share of such per cent of its Net demand and time liabilities (NDTL) that the Reserve Bank may notify from time to time.
Statutory Liquidity Ratio (SLR) The share of NDTL that a bank is required to maintain in safe and liquid assets, such as, government securities, cash and gold.
Repo Rate The interest rate at which the Reserve Bank provides overnight liquidity to banks against the collateral of government and other approved securities under the liquidity adjustment facility (LAF).
Reverse Repo Rate The interest rate at which the Reserve Bank absorbs liquidity, on an overnight basis, from banks against the collateral of eligible government securities under the LAF.
Marginal Standing facility (MSF) It is the rate at which Banks can borrow short term funds from RBI. Under MSF, banks can borrow funds from the RBI by pledging government securities within the limits of the SLR.
Open Market Operations (OMOs) These include both, outright purchase and sale of government securities, for injection and absorption of durable liquidity, respectively.
Market Stabilisation Scheme (MSS)  It is a monetary policy intervention by the RBI to withdraw excess liquidity (or money supply) by selling government securities in the economy, the mobilised cash is held in a separate government account with the Reserve Bank.

Note: The Policy Corridor in monetary policy of the RBI refers to the area between the reverse repo rate and the MSF rate

  • MSF is upper band of the Policy Corridor (lower band being the Reverse Repo rate). Thus value of MSF is tied with the value of Repo Rate. Usually RBI changes Repo rate and MSF changes automatically.
  • With this Quantitative Tools RBI also uses Qualitative Tools like fixing margin requirement, moral Suasion and selective credit control to fight inflation

Previous Year Questions (PYQs)

Q.1) With reference to the Indian economy, demand-pull inflation can be caused/increased by which of the following? (2021)

  1. Expansionary policies
  2. Fiscal stimulus
  3. Inflation-indexing wages
  4. Higher purchasing power
  5. Rising interest rates

Select the correct answer using the code given below.

  1. 1, 2 and 4 only
  2. 3, 4 and 5 only
  3. 1, 2, 3 and 5 only
  4. 1, 2, 3, 4 and 5

Q.2) Which of the following statements is/are correct regarding the Monetary Policy Committee (MPC)? (2017)

  1. It decides the RBI’s benchmark interest rates.
  2. It is a 12-member body including the Governor of RBI and is reconstituted every year.
  3. It functions under the chairmanship of the Union Finance Minister.

Select the correct answer using the code given below :

  1. 1 only
  2. 1 and 2 only
  3. 3 only
  4. 2 and 3 only

Source: Indian Express

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