RBI main objective as shared by Raghuram Rajan, Current Governor multiple times is to keep inflation within the limits so as not to reduce the buying power of poor in the country.RBI does this by controlling the free flow of money in market via changing repo rate which is the rate at which RBI lends to banks.
Whenever there is a increase in the repo rate, FD Rates/Deposit Rates also increases resulting in depositing more money in banks which will lead to less money available to buy goods thus putting a downward pressure on prices. On the other side when rates are decreased then people have less incentive to save but to spend money which will lead to increase money supply/demand/prices.
Whenever the inflation is within the comfortable limits, RBI usually decreases rates to reduce the borrowing cost which shall improve business activity in the market.
Banks does not always move the rates in the same proportion as per RBI does and usually been seen as front runner to decrease deposit rates and increase lending rates. RBI being the boss has come out with a innovative solution to help consumers which is MCLR. It is marginal cost of lending for bank decided for multiple time periods, Banks can add spread/credit risk premium as per their calculations. Full article is available at below link and i will try to explain it more in my next article.
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