On Friday, the Reserve Bank of India (RBI) unveiled its latest bi-monthly monetary policy review and, for the eighth time in a row, decided that it would not change the benchmark policy rate, also called the repo rate.

The repo rate is the interest rate at which the RBI lends money to commercial banks. When RBI wants to incentivise economic activity in the broader economy, it reduces the repo rate, which makes it cheaper for banks to borrow from it and lend onwards to customers. When it wants to disincentivise economic activity, it raises the repo rate, which makes it costly for everyone in the economy to borrow money.

Movements in the repo rate thus have a significant impact on the EMIs you pay for your car, home, or business loan.

What is the goal of RBI’s monetary policy?

The RBI has two goals.

The primary goal is to maintain price stability in the economy. Simply put, the RBI aims to ensure that prices do not fluctuate beyond a reasonable degree. This fluctuation is measured by the retail inflation rate — the rate of price rise that is faced by the average individual consumer.

By law, the RBI is required to target an inflation rate of 4%, which means that the general price level should go up by 4% from one year to another. Research suggests that this is the sweet spot where producers have an incentive to produce (and earn more) without being a huge disincentive for consumers (for whom inflation reduces purchasing power).

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The secondary goal for RBI is to promote economic growth. When economic activity needs a boost — like when the economy needs to recover from the shock of the Covid pandemic — the RBI cuts the repo rate to make it easy for consumers and producers alike to borrow money and spend. When inflation shoots significantly above the 4% mark — as in the wake of the Russia-Ukraine war — the RBI raises the repo rate to reduce the demand for credit-fuelled consumption. Higher repo rates also imply it pays more to keep money in the bank instead of spending it.

Why is the RBI not cutting interest rates?

Currently, the retail inflation rate has been coming down closer to the 4% mark. In fact, it has stayed within the so-called “comfort zone” of the RBI — anywhere between 2% and 6% — since September 2023 and yet, the RBI has not changed the repo rate since February 2023.

As the chart alongside shows, the repo rate was raised sharply between May 2022 and February 2023 but it has remained stagnant at the 6.5% level since then. Why?

There are four broad reasons for it.

📌 One, despite keeping the repo rate consistently high, the retail inflation has not dropped to touch the 4% mark since January 2021. Although it has declined, the rate of its decline has been very gradual. In fact, the RBI has expressed its concern over the stickiness of inflation. In the first four months of 2024, the inflation rate has been 5.10%, 5.09%, 4.85%, and 4.83%, respectively.

📌 Two, the RBI does not cut the repo rate as soon as the overall inflation rate falls to (or below) the 4% target in any one month. The RBI is, in the words of Governor Shaktikanta Das, “resolute in its commitment to aligning inflation to the target of 4.0 per cent on a durable basis”. The RBI has to be convinced that the inflation rate will stay around the 4% mark sustainably. The RBI’s policy statement predicts that inflation is likely to fall below the 4% target in the near future but that fall would only be due to temporary reasons.

📌 Three, as explained earlier, the RBI typically cuts the repo rate when it finds that economic activity needs a boost. However, India’s gross domestic product (GDP) growth rate has been surprisingly strong over the past year in particular. The RBI upped the GDP forecast for the current financial year from 7% to 7.2%. Das said this would be the fourth consecutive year of more than 7% GDP growth rate by India. Under the circumstances, it is unlikely that repo rates are holding back India’s economic growth.

📌 Four, although not articulated by the RBI per se, the decision may have to do with India’s forthcoming Union Budget. Most economists are waiting to see how the political compulsions of a coalition government will impact the Centre’s commitment to fiscal deficit — the amount of money the government intends to borrow from the market. Higher than anticipated fiscal deficit has implications for both inflation (if more fresh money is printed) or interest rates (if there is less money for the private sector to borrow).