RBI revised policy rates to contain the alarming rate of inflation despite of the shrinking money supply prompted by the recent auction of 3G Spectrum License and Advance Taxes.
On the given condition of the Macro Economic situation of India, RBI, considering the significant risk of inflation, has decided to revise its policy rates to counter the rising risk of inflationary pressure on the economic growth. Now, the fiscal deficit is no longer a cause of concern for the policy makers, as the government is able to cut the deficit by accumulating billions of dollars by selling off their stake in the public sector undertakings (PSU) however the downside risk to the global economy are much greater and the risks have risen sharply by an escalation of financial stress followed by the rising concern over the sovereign risk, which could lead to an increase in cost of capital and tighter lending condition for the corporates.
The RBI becomes Inflation Hawk to combat the alarming rate of inflation. It is for sure, the interest rates is expected to rise in the next few quarters and it would become detrimental to the economic growth.
The recent trend in the money supply shows (refer to below Figure) the decline in stock of money in India, tighten by absorbing the additional liquidity from the system. Recent auction of 3G (Third Generation Telecommunication Technology) Spectrum and advance taxes paid by the Indian companies have further stressed the liquidity in the system as the government’s cash balances gone up. However, the another significant step made by the Indian Government to gradually de-regulate the diesel prices in the country, which will allow the fiscal consolidation and will further help to reduce the country’s fiscal deficit, (which is at 9.81 per cent of the total GDP of India) largely dilated by the heavy subsidy on fuel. It will also further improve the country’s long-term sovereign debt rating.
There have been a significant economic growth in the past three-quarters and the robust growth recorded in the manufacturing sector, aided by the expanding exports, which is showing the strength of the economic growth, however the outlook continues to woe by the economic disturbances in the European economy. Developments on the inflation front has raised several concerns. The Wholesale Price Index (WPI) inflation increased to 10.2 per cent in May 2010, up from 9.6 per cent in Apr, 2010. But it is observed that the inflation will settle down to the lower levels on account of good monsoon rains in the several parts of the country. Over the period of time, inflation would ease-off however, the core commodity prices will continue to rise backed by the economic headway, which will deter the inflation to fall below six per cent. Thus, the central bank has announced its policy stance to counter inflation, to make economic progress. In the last policy decision, after the policy rate revision by 25 bps, the Central Bank’s Repo rate stands at 5.50 percent and Reverse Repo rate stands at 4.00 percent. Now on 27th Jul, 2010 in the First quarter monetary policy, RBI has revised the policy rates once again. Repo rate increases by 25 bps to 5.75 percent and Reverse Repo increases by 50 bps to 4.50 percent.
VMW Resources for Students/Individuals
Repo Rate: is nothing but a Repurchase Agreement. It’s a rate at which, RBI sells Govt Securities to the commercial banks to drain surplus liquidity. Both repo and reverse repo are a part of open market operations.
Reverse Repo Rate: Vice versa of Repos means to buy Gov’t securities in exchange of cash and adds liquidity in the system.
CRR: is a Cash Reserve Ratio. Banks kept some portion of their deposits with the RBI at a prescribed reserve rate.
SLR: is the Statutory Liquidity Ratio at which banks need to kept short-term securities such as Cash, Gov’t Securities, Precious Metals like Gold and Silver and other short-term securities.
BPS: is Basis Points which would be defined by One Hundredth of a one percentage point (1/100th of 1%). It is commonly used in expressing differences of interest rates. Incase, you need further support, please contact VMW Student Support at email@example.com
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