Every two months, the Monetary Policy Committee of the Reserve Bank of India (RBI) meets to discuss whether the prevailing interest rates in the country are appropriate or require upward or downward adjustments. the decline.

Currently, the prevailing interest rates in the country are very low. Rates were lowered about two years ago when we were in the midst of a pandemic. Low interest rates support the growth of the economy: money is then available at lower rates and people are willing to avail loans, which in turn keeps the wheels of the economy turning. economy a little faster.

To date, things have normalized in the country – economic growth is returning and there is a need to normalize (read increase) interest rates. With inflation somewhat higher, the real returns net of inflation on your deposits are now in negative territory. The RBI is mandated to balance inflation with growth. Now, when we say “prevailing interest rate in the country”, it does not imply that the RBI will decide every interest rate. Instead, the central bank sends signals.

The main signal is the repo rate, the rate at which the RBI would finance banks, should they need money, one day at a time, currently held at 4%. The committee met last Friday and decided that the repo rate would remain at 4%, at least until the next review on June 8. However, there were enough clues that rate normalization is coming. What are these clues?

The first is a projection on inflation, on the basis of which the RBI decides interest rates. In the previous policy review on February 10, the RBI forecast consumer price index (CPI) inflation for 2022-23 at 4.5%. This was well below economists’ and analysts’ forecasts, which were north of 5%. Subsequently, we had high crude oil prices, metal prices and fertilizer prices due to the Russian-Ukrainian war. RBI has revisited these issues and revised the projection upwards to 5.7% for 2022-23. This is a steep revision, from 4.5% to 5.7%, implying that the RBI will turn to rate hikes to contain inflation.

On the interest rate signal, which is the repo rate currently at 4%, there is another leg, called the reverse repo. When banks have excess money, they store those funds with the RBI, one day at a time, at the reverse repo rate, currently at 3.35%.

In the last policy review, the RBI removed reverse repo and instead launched a scheme called Permanent Deposit Facility (SDF). This SDF is at 3.75%, therefore, the other leg has effectively been increased from 3.35% to 3.75%.

The technical difference between reverse repo and SDF is that in reverse repo, RBI gives government securities as collateral to banks, whereas in SDF, there is no collateral as collateral.

While announcing the policy after the press conference, the RBI Governor clarified that in the sequence of priorities, inflation will come first, followed by economic growth. For a while, especially during the pandemic-induced growth slowdown, growth was a priority. The implication is that even if real deposit rates were negative, interest rates would be low. Now, with inflation being the priority, the RBI will seek to achieve positive real interest rates, over a period of time.

Another aspect of the interest rate signal, apart from the repo rate, is the amount of cash floating around in the banking system. High liquidity is conducive to lower interest rates, as banks have a lot more to lend to. Right now, the banking system has a huge excess of liquidity, which would work against rate hikes, as they happen. The RBI Governor clarified that excess liquidity would be withdrawn over several years, in a non-disruptive manner.

What does all this mean for you and your investments? The shift in priorities by the RBI is not a game changer, it must have happened at some point, given concerns over inflation and the normalization of economic activities. The increases would be gradual, which the economy will take at its own pace.

Joydeep Sen is a business trainer and author.

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