RBI raises interest rate by 25 basis points – What does it mean?

8 Feb 2023 , 10:37 AM

Reserve Bank of India today raised interest rate by 25 basis points or 0.25%. This is the sixth consecutive interest rate hike by the Indian central bank, since the beginning of 2022. Most were expecting a 25-basis point hike. Some experts and economists were expecting the RBI to not announce any interest rate hike today.

Repo rate is the rate at which RBI lends to banks. It serves as the effective benchmark interest rate in India. After this hike, the repo rate in India stands at 6.50%. This means that interest rate on loans in India, across categories, will at least be more than 6.50%.

After the US central bank increased interest rate last week, RBI had one more reason to increase interest rate in India. Increasing interest rate in India will help in defending the Indian rupee against the dollar. Currency of a country tends to appreciate when its interest rate rises against the interest rate of other countries.

The central bank today also said that it will continue to maintain its current monetary policy stance of withdrawal of accommodation. Withdrawal of accommodation means that the central bank will continue to pursue a contractionary monetary policy. Contractionary monetary policy is increasing interest rates and reducing money supply in the economy. 

The expectation was that RBI will tone down its hawkish stance today. It was expected that it will adopt a neutral monetary policy. Neutral monetary policy is when a central bank does not pursue an expansionary monetary policy or a contractionary one. 

The continuation of contractionary monetary policy stance will be a disappointment for equity markets. Increase in interest rate raises the cost of interest sensitive consumption and investment. This in turn lowers the growth rate of the economy. India has high unemployment rate. It is currently at more than 8%. Therefore, India also needs high economic growth to generate more employment for its youth. 

For 2023-24, RBI today forecasted that real GDP growth rate will be at 6.4%. For FY 23, it has said that retail inflation will be at 6.5%. For FY 24 it has forecasted that retail inflation will be at 5.3%.