RBI hikes repo rate by 25 basis points to 5.5%

• The Monetary Policy Committee (MPC) held its 63rd meeting from October 5 to 7, under the chairmanship of Reserve Bank of India (RBI) Governor Sanjay Malhotra. 

• After a detailed assessment of the evolving macroeconomic and financial developments and the outlook, the MPC voted to increase the policy repo rate by 25 bps to 5.50 per cent.

• Repo rate, which is also known as the benchmark interest rate, is the rate at which the RBI lends money to the banks for a short term. Reverse repo rate is the borrowing rate at which RBI borrows money from banks for a short term.

• With the rate hike, home loans, vehicle loans and corporate loans would become expensive and EMI for existing borrowers would also go up.

• The last repo rate hike was in February 2023, when the RBI raised the rate by 0.25 per cent to 6.50 per cent. It kept the rate unchanged through 2023-24 before beginning its rate-cut cycle in 2025.

• The MPC changed its stance to ‘calibrated tightening’ from ‘neutral’ and also underscored that rate cut is unlikely in the near term given the current conditions.

• A ‘calibrated tightening’ stance allows the RBI the choice to either hike rates or take a pause depending on evolving inflation conditions.

Rationale for these decisions

• The sudden re-escalation of the West Asia conflict in September and the consequent hardening and volatility in global crude prices soured global economic sentiments and heightened financial market volatility. 

• Although global growth remains resilient, it is projected to decelerate in 2026 from the previous year. 

• Driven by escalating energy costs and rising food prices, global inflation is projected to increase sharply prompting monetary policy tightening by major central banks. 

• Lingering trade uncertainty, rising bond yields in advanced economies and an appreciating dollar are keeping global financial market sentiments nervous and fragile. 

• Further tightening of global financial conditions, uncertainty about fair valuation of AI stocks, and an elusive resolution of the West Asia conflict pose significant downside risks to the global economic outlook.

• In light of available data, it is clear that inflation and its outlook are not benign as they were last year, with headline CPI inflation expected to average almost 5.8 per cent in the next three quarters and core inflation projected at 4.4 per cent this financial year. 

• In this milieu, recalibrating the policy rate is imperative, the MPC said.

Understanding the monetary policy by RBI

• Monetary policy refers to the use of monetary instruments under the control of the central bank to regulate magnitudes such as interest rates, money supply and availability of credit with a view to achieving the ultimate objective of economic policy.

• The Reserve Bank of India (RBI) is vested with the responsibility of conducting monetary policy. This responsibility is explicitly mandated under the Reserve Bank of India Act, 1934.

• The primary objective of monetary policy is to maintain price stability while keeping in mind the objective of growth. Price stability is a necessary precondition to sustainable growth.

• In May 2016, the Reserve Bank of India (RBI) Act, 1934 was amended to provide a statutory basis for the implementation of the flexible inflation targeting framework.

• The amended RBI Act also provides for the inflation target to be set by the government of India, in consultation with the Reserve Bank, once in every five years.

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

Members of MPC

• There are six members in the MPC and the RBI Governor is the chairperson.

• As per the provisions of the RBI Act, out of the six members of the Monetary Policy Committee, three members will be from the RBI and the other three Members of MPC will be appointed by the central government.

Composition of MPC:

a) The Governor of the RBI — chairperson, ex officio

b) Deputy Governor of the RBI, in charge of Monetary Policy — member, ex officio

c) One officer of the Bank nominated by the Central Board — member, ex officio

d) Three persons appointed by the central government — members.

• The MPC is required to meet at least four times in a year.

• The Reserve Bank’s Monetary Policy Department (MPD) assists the MPC in formulating the monetary policy.