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Long-Term Repo Operations

Prelims – Economy, Mains – Economic Development

1. RBI has announced long-term repo operations (LTROs), an instrument outside the framework of the Monetary Policy Committee (MPC) aimed at lowering the cost of lending of banks.

2. Under this, RBI will lend up to ₹1 trillion funds to banks for one-year and three-year durations at its policy repo rate of 5.15%.

What was the reason for announcing LTROs?

1. Due to many reasons, banks have been parking their surplus funds with RBI instead of lending.

2. So, credit growth has gone below nominal gross domestic product growth.

3. MPC is also constrained in lowering interest rates due to increasing inflation.

How are LTROs beneficial?

1. As credit growth is weak, no significant pick-up in lending will take place because of two reasons,

a. Lower demand for loans as investment sentiment is low.

b. Weaker lending by bankers fearing harassment by probe agencies for loan defaults, including those due to economic reasons.

2. Reduction in the cost of funds under LTROs can make banks lend more loans.

3. Even if banks invest the money borrowed under LTROs in government bonds, the cost of borrowing for the Centre will decrease.

Where does inflation stand?

1. The RBI has revised its consumer price inflation forecast upward to 6.50% for the March quarter and 5-5.40% for April-September.

2. This was due to the rise in the prices of vegetables and food items such as milk, pulses, meat and eggs.

3. This was also an effect of the one-time hike in custom duties on some items in the budget.

Why do banks reduce deposit rates?

1. The weighted cost of deposits of banks is already lower than the repo rate.

2. With the LTRO window available to raise significant funds at the repo rate, banks will not incrementally raise deposits at higher rates.

3. So, deposit rates are likely to decrease. Fixed deposit (FD) rates have already been cut by many banks following the LTRO policy.

Which are the impacts on real deposit rates?

1. Inflation erodes the real value of money over time. For instance, what a rupee could purchase 50 years ago, it can no longer buy today.

2. As per RBI’s projections, inflation is likely to remain nearly equal to, or in some cases even exceed, interest rates on deposits.

3. So, real returns from these savings instruments will suffer and may even turn zero or negative.

4. This is mainly because the LTRO window will not let banks offer higher rates rather will reduce the rates.

Source: Live Mint