RBI IS CENTRAL TO THE COUNTRY'S ECONOMY

Apart from deciding interest rates, the central bank wields humongous influence on various aspects of finance and economy, which is why the RBI governor's position is such a big deal

- SUNITHA NATTI @Hyderabad

suring adequate flow of credit to productive sectors, RBI has several direct and indirect monetary instruments at its disposal. These include repo rate, reverse repo rate, marginal standing facility rate, bank rate, cash reserve ratio, open market operations, market stabilisation scheme and so on.

By tweaking short-term rates, i.e., either raising or lowering of the overnight repo rate, RBI controls the supply of demand for money in the economy and thereby economic activity and inflation. For example, if the economy is growing too fast and inflation is high, it raises the repo rate, or the interest rate it charges banks to lend money. Higher rates will then permeate into other rates like housing loans and as the cost of borrowing increases, it discourages consumption and investment, thereby reducing growth and taming inflation.

On the other hand, if the economy is growing too slow or if the inflation is too low, the central bank lowers the repo rate, which feeds into other rates, encouraging spending and investment thereby spurring growth and inflation.

The art of setting interest rates is to be ahead of the game, which is to raise rates before inflationary pressures seep in and to cut them before the economy weakens too much, but it isn't as simple as it sounds. For, at any given point, multiple other variables will be at play. There are several instances of central banks falling behind or ahead of the curve.

In the past, there wasn't any set target for retail inflation, but in 2016, after much deliberations, India adopted a committee-based approach, ensuring transparency to monetary policy decisions.