Emphasised Cost of Funds Policy, A Strong Monetary Policy is on Its Way

Main Issue

We are living in the 21st Century where we have seen many Fundamental Revolutions in the Administrative Sector as well. So, It's mandatory to make good compliance with the current needs to have a Better Atmosphere for the Citizens of India.

Our Policy Makers and Advisors are also observing these Fundamentals closely and now came with the Proposal to Set Expectations right about guiding the Economy towards normality in its cost of funds.

In this article, I will take you through the Policy and detailed discussion about the REPO rates and Its Influences.

First of All, We have to have some proper explanation about Our Monetary Policy Committee and their Policy-Making Procedure.

Monetary Policy Committee

As we all know about Our Central Bank Reserve Bank of India's glorified previous policy which helps our Countries GDP Growth, I will definitely walk through the Section which is the Charging Section of Introduction of MPC.

The Monetary Policy Committee (MPC) constituted by the Central Government under Section 45ZB determines the policy interest rate required to achieve the inflation target.

The Reserve Bank’s Monetary Policy Department (MPD) assists the MPC in formulating the monetary policy. Views of key stakeholders in the economy, and analytical work of the Reserve Bank contribute to the process for deciding on the policy repo rate.

The Financial Market Committee (FMC) meets daily to review the liquidity conditions to ensure that the operating target of monetary policy (weighted average lending rate) is kept close to the policy repo rate.

The Monetary Policy Framework

The amended RBI Act explicitly provides the legislative mandate to the Reserve Bank to operate the monetary policy framework of the country.

The framework aims at setting the policy (repo) rate based on an assessment of the current and evolving macroeconomic situation, and modulation of liquidity conditions to anchor money market rates at or around the repo rate. Repo rate changes transmit through the money market to the entire financial system, which, in turn, influences aggregate demand – a key determinant of inflation and growth.

Once the repo rate is announced, the operating framework designed by the Reserve Bank envisages liquidity management on a day-to-day basis through appropriate actions, which aim at anchoring the operating target – the weighted average call rate (WACR) – around the repo rate.

The operating framework is fine-tuned and revised depending on the evolving financial market and monetary conditions while ensuring consistency with the monetary policy stance. The liquidity management framework was last revised significantly in April 2016.

So Now we know What the Policy Committee is and their Policy Frameworks but I will tell about their Policy Making Procedures also to take deep dive into that matter.

Monetary Policy Process of the Monetary Policy Committee

Let's dive into their Policy-Making Procedure.

The preparations for the MPC’s meeting up to the monetary policy announcement (day T), adopt the following broad timelines :

• T-45 to T-30 days before the policy announcement: launch of the key monetary policy surveys which include the industrial outlook survey, services and infrastructure outlook survey, order books and capacity utilisation survey, bank lending survey, a survey of inflation expectations of households and the consumer confidence survey.
• T-25 to T-15 days before policy announcement: following the monthly release of the index of industrial production (IIP) and the consumer price index (CPI) by the National Statistics Office (NSO), an Inter-Department Group (IDG) on inflation and growth starts preparing a detailed analysis of the recent developments in inflation and growth. The survey of professional forecasters (SPF) is also launched.
• T-14 to T-10 days before the policy announcement: the MPC Secretariat arrives at a common set of assumptions for projections of inflation and growth. Based on these baseline assumptions, the IDG makes the first round of inflation and growth projections. Scenario analysis based on the risks to the baseline projections are also prepared. Pre-policy consultations, which include meetings with economists, trade bodies, and financial market participants are held under the chairpersonship of the Governor.
• T-9 to T-3 days before the policy announcement: monetary policy strategy (MPS) meeting dry run presentations to the top management are made on the results of the forward-looking surveys and the deep-dives on inflation and growth.
• T-2 to T: meetings of the MPC commence, starting with the presentations on monetary policy surveys, inflation and growth deep-dives which includes the inflation and growth assessment, outlook and scenario analysis. After the presentations, the MPC members have closed-door deliberations to arrive at the monetary policy decision and to finalise the MPC resolution.
• The day of policy announcement (T): Governor makes a Statement to the press; the MPC resolution is released followed by a press conference.
• T+14: release of the minutes of the MPC meeting.

Emerging Issues Regarding the Policy

According to the Minutes of the Monetary Policy Committee (MPC) meeting, held earlier this month showed that Members in General, favour leaving policy rates unchanged for a considerable period of time.

External Member Mr J R Verma cited in the MPC Minutes published that there is an Urgent Need to Prioritise the message that the MPC's inflation target is 4% and that market rates should move towards the 4 % repo rate, calling for restraints in monetary accommodation.

He also argued regarding the Greater Effectiveness of Monetary Policy than Fiscal Policy for providing Relief to the worst affected by the Pandemic.

Central REPO Rate

In the previous paragraph, we are talking about the REPO Rate.

Now we will have a clear concept regarding REPO, What is REPO? , What is the Influence of REPO on our Economy?

Repo rate refers to the rate at which commercial banks borrow money by selling their securities to the Central bank of our country i.e Reserve Bank of India (RBI) to maintain liquidity, in case of shortage of funds or due to some statutory measures. It is one of the main tools of RBI to keep inflation under control.

How Does Repo Rate Work

When you borrow money from the bank, the transaction attracts interest on the principal amount. This is referred to as the cost of credit. Similarly, banks also borrow money from RBI during a cash crunch on which they are required to pay interest to the Central Bank. This interest rate is called the repo rate.

Technically, repo stands for ‘Repurchasing Option’ or ‘Repurchase Agreement’. It is an agreement in which banks provide eligible securities such as Treasury Bills to the RBI while availing of overnight loans. An agreement to repurchase them at a predetermined price will also be in place. Thus, the bank gets the cash and the central bank the security. The following table shows the most recent repo rates maintained by the Reserve Bank of India:

Date of Update Rate

4 December 2020 4.00%

9 October 2020 4.00%

06 August 2020 4.00%

22 May 2020 4.00%

27 March 2020 4.40%

6 February 2020 5.15%

5 December 2019 5.15%

4 October 2019 5.15%

7 Augst 2019 5.40%

6 June 2019 5.75%

4 April 2019 6.00%

7 February 2019 6.25%

What are the Components of a Repo Transaction

Below are the parameters based on which the RBI agrees to execute the transaction with the banks:

• Preventing Economy “squeezes”?– The Central bank increases or decreases the Repo rate depending on the inflation. Thus, it aims at controlling the economy by keeping inflation within the limit.
• Hedging & Leveraging –?RBI aims to hedge and leverage by buying securities and bonds from the banks and provide cash to them in return for the collateral deposited.
• Short-Term Borrowing –?RBI lends money for a short period of time, the maximum being an overnight post in which the banks buy back their securities deposited at a predetermined price.
• Collaterals & Securities –?RBI accepts collateral in the form of gold, bonds etc.
• Cash Reserve (or) Liquidity –?Banks borrow money from RBI to maintain liquidity or cash reserve as a precautionary measure.

How Does Repo Rate Affect the Economy

Repo rate is a powerful arm of the Indian monetary policy that can regulate the country’s money supply, inflation levels, and liquidity. Additionally, the levels of repo have a direct impact on the cost of borrowing for banks. The higher the repo rate, the higher will be the cost of borrowing for banks and vice-versa.

Rise in inflation

During high levels of inflation, RBI makes strong attempts to bring down the flow of money in the economy. One way to do this is by increasing the repo rate. This makes borrowing a costly affair for businesses and industries, which in turn slows down investment and money supply in the market. As a result, it negatively impacts the growth of the economy, which helps in controlling inflation.

Increasing Liquidity in the Market

On the other hand, when the RBI needs to pump funds into the system, it lowers the repo rate. Consequently, businesses and industries find it cheaper to borrow money for different investment purposes. It also increases the overall supply of money in the economy. This ultimately boosts the growth rate of the economy.

Current Repo Rate and its Impact

RBI keeps changing the repo rate and the reverse repo rate according to changing macroeconomic factors. Whenever RBI modifies the rates, it impacts all sectors of the economy; albeit in different ways. Some segments gain as a result of the rate hike while others may suffer losses. RBI recently cut down the repo rate by 25 basis points to 5.15% from 5.75%. In the same line, the reverse repo rate was also reduced to 4.9% from 5.5%.

Changes in the repo rates can directly impact big-ticket loans such as home loans. The decrease in repo rates is to aim at bringing in growth and improving economic development in the country. Consumers will borrow more from banks thus stabilizing inflation.

A decline in the repo rate can lead to the banks bringing down their lending rate. This can prove to be beneficial for retail loan borrowers. However, to bring down the loan EMIs, the lender has to reduce its base lending rate. As per the RBI guidelines, banks/financial institutions are required to transfer the benefit of interest rate cuts to consumers as soon as possible.

Conclusions

We are on the verge of the Revolution in the Administrative Section in our Govt is indeed Great News for the citizens of India as we are looking for changes in the Policy.

As we all keen to know about the Policy, Our Govt is bringing some Brand New stuffs like Fundamentals changes in the Repo rate which will help borrowers in the Long Run, Blockchain Concept for Startups where they will get all necessary things within the same roof and Strategic alliance in the G-20 OECD framework to give relief to the MNC's.

As a Citizen of India, we can hope for the Betterment of Our Economy through the above-mentioned Improvisation as a Silver Linings in Our Sky.

We can quote Percy Bysshe Shelley's famous Lines to add value to My Article

O, wind, if winter comes, can spring be far behind?