The Key Rate Hike by RBI to contain Inflation

Policy Measures:

RBI has hiked the Cash Reserve Ratio by 50 bps to 6.50% (in two tranches of 25 bps each)

RBI has hiked the Repo Rate from 7.50% to 7.75% with immediate effect

The incremental interest on CRR deposit has been reduced from 1% to 0.5%

Why:

Inflation has been a major concern in India for past few months. The possibility of higher inflation damaging the prospects of ruling party gave it a sense of urgency. The central bank, RBI, in a latest move to contain the inflation has hiked the two key rates, the Cash-Reserve- Ratio (CRR) and Repo Rate.

The CRR is the liquid assets which the banks have to maintain at RBI as a proportion of their deposits. Clearly, higher the CRR, lower is the amount available for lending implying less amount of money circulating in the economy (rememeber the standard texbook example of money multiplier).

The repo rate is the rate at which the central bank lends to the banks.

Thus, increase in both these measures are aimed at taking out as much money out of the system as possible. It is expected that a sum of close to Rs. 15000 crore will be sucked out of the banking system due to these measures.

Another measure actively used by the RBI has been allowing a slow appreciation of the Rupee against the dollar, as evident in the figure at the top. But it has limitations, given that too much appreciation will hurt exporters. Some other measures are also being tried, like banning the exports of some commodities, imports of some items.