Prelim Bit: Repo Rate and the Monetary Policy Committee

Why in news?

The RBI announces its policy decision on the repo rate several times a year, and questions on monetary policy are asked regularly. This sample note shows the Prelim Bits format with the fundamentals.

Background

India follows flexible inflation targeting. The government sets the inflation target, and the Reserve Bank of India uses its policy rate to meet it. The Monetary Policy Committee (MPC) decides the policy rate.

Key points

• Repo rate is the rate at which the RBI lends short-term funds to banks against government securities.
• Reverse repo is the rate at which the RBI borrows from banks.
• The MPC has six members: three from the RBI (including the Governor) and three external members appointed by the Central Government.
• Decisions are taken by majority; the Governor has a casting vote in case of a tie.
• The inflation target is 4% with a tolerance band of 2% on either side, measured by CPI.

Prelims pointers

• A higher repo rate makes borrowing costlier and tends to reduce inflation; a lower one does the opposite.
• The MPC fixes the repo rate; it does not set the CRR or SLR in the same way as a policy rate decision.