Deliberations on the Rate Cut Policy

On the 4th of October’16, in its first public pronouncement as the RBI Governor, Dr. Urjit Patel announced to cut repo rate by 25bps bringing it to 6.25%, a 6 year low.

“Many claim that the recent policy change of rate cut by RBI was under the duress of central government.”

“Others are of the opinion that the rate cut was a justified act of the newly appointed Governor and has no co-relation with the central government.”

Whatever it may be, the recent policy decision, to cut the interest rate by 25 bps, has different implications for different lines of sectors in the economy.

urjit-patel-5-9-16

Q- How will the decision to cut repo rate affect the consumers’?

The rate cut by the central government was also followed by a reduction of the interest rates on the small savings scheme by 0.1% for the October-December quarter of this fiscal year. The schemes include Public Provident Fund, Kisan Vikas Patra, and Sukanya Samriddhi Account.

With reduction in the rep rate, the banks are expected to pass on the rate cut benefits to their customers by offering them cheap home and vehicle loans and also the EMI of existing customers are likely to come down.

This move by RBI if adopted by the banks will not only facilitate the existing customers but will also attract more customers to the financial institutions. Also this cheap credit policy will lead to an increase in the demand for loans, leading to an increase in money supply in the economy and in turn adding to the existing demand for goods and services and enabling an economic growth.

In the light of the increase in the money supply, following the spur in growth, chances are that this will lead to a rise in the level of inflation. This move by RBI was taken to negate the forecast of the low levels of Inflation expected this quarter; we hope this act does not turn out to be a double-edged sword.

Q- How has India Inc. reacted to RBI’s 25 bps repo rate cut?

Industry Leaders have welcomed the RBI decision to cut down the repo rate as this rate cut is ought to translate into low lending cost for both the corporate and the public.

This will have a great impact on the income multiplier effect as it will increase lending and investment activity in the economy and therefore correspond to an increase in the consumption activity and demand. This will sure work as a catalyst for growth and will lead to a spur in growth.

Also, the Finance Ministry endorsed the central bank’s move to cut the repo rate, stating that the move will boost liquidity in the system.

“On the whole, this is a decision which will go down well with all sections of the Economy”- Union Finance Secretary, Ashok Lavasa.

Note: The ideas in this blog are from the viewpoint of the author and the team. 

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2 thoughts on “Deliberations on the Rate Cut Policy

  1. The reduction in repo rate will benefit the customers only if the commercial banks pass on this benefit to the ultimate consumers…time and again it has been seen that banks do not pass on this rate cut and the bank rates and EMI remain the same… What can the RBI do to further ensure that this benefit is passed on???and why do banks, in the first place,not reduce their rates??

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    1. At the time of Raghuram Rajan, when also the benefits of rate cut by RBI did not fully reach the customers, the RBI then decided to change the structure of calculation of lending rate. The Marginal Cost of Funds based Lending Rate (MCLR). This did not only improved the transmission of policy rates into the lending rates of banks, but also improved the transparency in the methodology followed by banks for determining interest rates. In this way it ensured that the benefits reach the customers as well.
      And yeah, this rate cut was the repo rate cut, it is the rate at which the central banks lends money to the commercial banks. Banks see it this way, they can easily avail cheap credit now but, they grant those credit to their customers at a higher rate. the difference between repo rate and the bank rate is thus counts for the extra penny earned by the banks.

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