Is inflation-targeting is a right practice at this time?

The Reserve Bank of India (RBI) has announced that the country has succeeded to contain inflation and regarding this RBI decided to stop raising interest rates.

• This decision can impact the economy, as there exists no evidence that inflation has gone and contained completely.

The rate hikes by RBI:

• The recent pause in the rate hike is necessary as a high base effect during March-October was expected to ease pressure on the headline retail inflation rate.
• The moderation in the inflation rate forecast for FY24 to 5.2 per cent from 5.3 per cent earlier has imparted some breathing space to the RBI to pause its rate hike cycle. 

Reasons to ease the rate hikes:

• The move is seen as significant, as there are lingering concerns over the entrenched and high core inflation – the non-food, non-fuel component of inflation.
• The RBI also outlined risks from;
  • Protracted geopolitical tensions,
  • Tight global financial conditions and
  • Global financial market volatility to its monetary policy outlook.
• Global financial market volatility has surged, with potential upsides for imported inflation risks.

What is the Repo rate?

• Repo stands for “Re Purchase Option”.Repo Rate is the rate at which the central bank (Reserve Bank of India) lends to other banks by buying the securities with an agreement that the bank will buy back on a certain date.
• Repo lending is a short-term lending option to meet the liquidity requirements of commercial banks.
• The repo rate is the rate at which the Reserve Bank of India (RBI) lends to other banks.
• It is a part of the Liquidity Adjustment Facility (LAF)of the RBI.

Components of Repo Rate:

• Preventing "squeeze" in the economy -The central bank adjusts the Repo rate in response to inflation. As a result, it seeks to govern the economy by keeping inflation under control.
• Hedging and Leverage- The RBI tries to hedge and leverage by purchasing securities and bonds from banks and providing cash in exchange for collateral deposited.
• Short-Term Borrowing— The RBI lends money for a short length of time, up to an overnight period, after which banks purchase back their deposited securities at a predetermined price.
• Collateral and Securities— The RBI takes gold, bonds, and other forms of collateral.
• Cash Reserve or Liquidity: Banks borrow money from the Reserve Bank of India (RBI) to preserve liquidity or cash reserves as a precautionary measure.

Impacts of repo rate:

• The increased repo rate will discourage banks to borrow from the RBI and lending to customers.
• This in turn will reduce the liquidity and demand in the market.
• It is part of the contractionary monetary policy.
• On the other hand, decreased repo rate will encourage banks to borrow and lend to customers increasing the liquidity and demand in the market. This is a part of the Expansionary Monetary Policy.