Monetary Policy, CRR, SLR, Repo & Reverse Repo Rate
We learnt earlier that monetary policy administered by the central bank controls the lending and interest rates with the objectives of controlling inflation and promoting growth. Under the series of ‘Economics made Easy’, in this blog we shall study ‘Monetary Policy, CRR, SLR, Repo & Reverse Repo Rate’ with special focus on India and RBI.
Understanding Interest Rates
Bank rate is the rate at which RBI lends money to commercial banks without any collateral. The current bank rate in India is 7.75%.
Repo and Reverse Repo Rates
The repo rate is also called the key short term lending rate. If banks are short of funds they can borrow from the RBI at the repo rate, the interest rate with a 1 day maturity. The current value of repo rate is 6.75%. If RBI wants to put more money into circulation, then it will lower the repo rate. The reverse repo rate is the interest rate that banks receive if they deposit money with RBI. Its current value is 5.75%. Increases or decreases in the repo and reverse repo rate have an effect on the interest rate on banking products such as loans, mortgages and savings.
Other Monetary Tools of RBI
Cash Reserve Ratio (CRR)
CRR is a percentage of deposits which banks are required to keep with RBI in the form of reserves or balances. Higher the CRR with the RBI lower will be the liquidity in the system and vice versa. RBI is empowered to vary CRR between 15 percent and 3 percent. As of September 2015, the CRR is 4.00 percent.
Statutory Liquidity Ratio (SLR)
Every financial institution has to maintain a certain quantity of liquid assets with themselves at any point of time of their total time and demand liabilities. These assets have to be kept in non cash form such as precious metals, approved securities like bonds. This ratio is termed as the SLR. The current SLR is 21.5%.
Open Market Operations
An open market operation involves buying or selling of government securities from or to the public and banks. This mechanism influences the reserve position of the banks, yield on government securities and cost of bank credit. The RBI sells government securities to control the flow of credit and buys government securities to increase credit flow.
Actions taken to Reduce/Increase Money Supply
In order to reduce inflation RBI can raise the value of repo rate, CRR, SLR and sell RBI bonds. This will cause a reduction in the money supply in the country. The increase in these rates affects growth adversely. Conversely lowering of these rates and buying RBI bonds from the market promotes growth by making credit available at cheap rates. This action is likely to increase inflation. To get an idea about India’s rates of interest compared to some other countries their values are given:
The above rates indicate that Japan and US are desperate to promote growth, while Brazil is desperate to check inflation.
Conclusion: Monetary Policy
RBI performs several other functions. However, the above discussed are the key functions to control inflation and promote growth in India.