MPC Retains Repo Rate, Lowers Growth Forecast

Syllabus: GS3/Economy

Context

• The Monetary Policy Committee (MPC) voted unanimously to keep the policy repo rate under the liquidity adjustment facility (LAF) unchanged at 5.25%.

About

• The standing deposit facility (SDF) rate remains at 5% and the marginal standing facility (MSF) rate and the Bank Rate at 5.50%.
• The real GDP growth for 2026-27 is projected at 6.6% down from earlier projection of 6.9% with Q1 at 6.6%; Q2 at 6.3%; Q3 at 6.5%; and Q4 at 6.8%. 
• CPI inflation for 2026-27 is projected to be at 5.1% which is 50 basis points more than the earlier projection with Q1 at 4.2%; Q2 at 5.1%; Q3 at 5.9%; and Q4 at 5.4%.

What is the Repo Rate?

• The repo rate is the rate at which the RBI lends short-term money to commercial banks. It is the key policy tool used by the RBI to control liquidity, inflation, and economic growth.
• A lower repo rate means banks can borrow from the RBI at cheaper rates. This encourages banks to lower lending rates, leading to:
  • Easier access to credit for consumers and businesses
  • Boost in investment, consumption, and economic activity
  • Increased liquidity and money supply
  • This can stimulate growth, especially during economic slowdowns.

What is the Monetary Policy Committee (MPC)?

• The MPC is a statutory body established under the RBI Act, 1934 (amended in 2016).
• It is responsible for fixing the benchmark interest rate (repo rate) to maintain price stability while keeping growth in mind.
• It consists of 6 members:
  • 3 from the RBI (including the Governor as Chairperson),
  • 3 external members appointed by the Government.
• Functioning: It meets at least four times a year (usually bi-monthly) and the decisions are made by majority, and each member has one vote. In case of a tie, the RBI Governor has the casting vote.

Flexible Inflation Targeting Framework (FITF)

• India adopted a Flexible Inflation Targeting Framework (FITF) in 2016. Under this, the government, in consultation with the RBI, sets an inflation target every five years.
• Under this framework, the Government sets the inflation target every five years in consultation with the RBI. The current mandate, effective until March 31, 2026, specifies a CPI inflation target of 4%, with a tolerance band of ±2%, i.e. between 2% and 6%.

Monetary Policy Tools in India

Various instruments used by the RBI to control the money supply can be categorized into two categories:

• Quantitative Tools: Quantitative tools of monetary policy are aimed at controlling the cost and quantity of credit.
• Qualitative Tools: Qualitative tools of monetary policy are aimed at controlling the use and direction of credit.

Quantitative Tools

• Repo Rate: Rate at which RBI lends short-term funds to banks against collateral.
• Reverse Repo Rate: Rate at which RBI absorbs liquidity from banks.
• Cash Reserve Ratio (CRR): Portion of deposits banks must keep with RBI in cash.
• Statutory Liquidity Ratio (SLR): Portion of deposits kept in liquid assets (gold, cash, securities).
• Open Market Operations (OMO): Buying/selling of government securities to control liquidity.
• Marginal Standing Facility (MSF): Emergency borrowing by banks at a penal rate.
• Liquidity Adjustment Facility (LAF): Framework for repo/reverse repo operations.
• Market Stabilisation Scheme (MSS): Bonds issued to absorb excess liquidity.

Qualitative Tools

• Margin Requirement: Controls loan-to-value ratio.
• Consumer Credit Regulation: Regulates credit terms.
• Rationing of Credit: Limits sectoral lending.
• Moral Suasion: Persuasive guidance by RBI.
• Direct Action: Penal action against non-compliant banks.

Reasons Behind the recent Policy Decision

• Geopolitical Uncertainty: The MPC decided to maintain the repo rate due to heightened geopolitical tensions in West Asia, which have worsened global economic uncertainty.
• Supply-Side Shock: The MPC highlighted that the Indian economy is facing a supply-side shock, primarily due to disruptions in energy and commodity markets.
• Inflation Within the Target Range: Retail inflation remains within the 2–6% target band, and core inflation is contained limiting the need for immediate policy action.
• Impact of Trade Agreements: India recently signed trade agreements with the United States, the European Union, Oman and New Zealand.
  • These agreements are expected to boost exports and investments, reduce external vulnerabilities, and support medium-term growth.

Impact on the Indian Economy

• Impact on Borrowers and Households: Stable interest rates reduce financial uncertainty for middle-class households and housing loan borrowers.
• Impact on Investment and Credit Growth: Stable interest rates, strong demand conditions, and trade agreements create a predictable environment for private investment.
• Macroeconomic Stability: The decision reinforces the credibility of India’s Flexible Inflation Targeting framework and demonstrates institutional stability in monetary policymaking.

Way Ahead

• Safeguard External Sector Stability: Active liquidity management, prudent forex reserve deployment, and monitoring of global financial conditions are necessary to cushion against external shocks.
• Enhance Fiscal-Monetary Coordination: Continued fiscal consolidation alongside targeted public spending will complement monetary policy and sustain long-term growth without triggering inflationary pressures.

Source: TH