Reasons for Repo rate cut by RBI and impact on economy
Reasons for Repo rate cut by RBI and impact on economy
Q. What are the reasons for the repo rate cut by the RBI and its impact on the economy and policy formation?
About Repo Rate
Repo Rate
• Rate at which banks lend money
• Cut by 25 basis points on 15th January 2015 to 7.55% from 8.0%
• Termed a “surprise rate cut” by the markets
Other Indices
• Cut in reverse repo rate by 25 basis points to 6.75%
• Cash Reserve Ratio (CRR) remains same
A. Reasons For RBI Rate Cut
1. Lowering of Inflation
• Wholesale price index for December rose by only 0.11% Y-O-Y(year on year)
• Retail inflation rose to 5% in December, 6% aimed for next year
• Softening of inflation
• Fall in prices of vegetables, fruits and other commodities
2. Fall in Crude Oil Prices
• International oil prices currently at 6 year low of USD 45 per barrel
• Sharp fall in pump price of petrol and diesel
• Resulting reduction in inflation and oil import bill
• Lowering subsidy of kerosene and cooking gas
• Global glut in oil production
• Increased US shale oil production
• OPEC’s refusal to cut output
• Oil prices at record low
3. Government’s Aim to Control Fiscal Deficit
• Govt. aims for certain fiscal deficit target
• Fall in oil prices likely to keep deficit in check
4. Weak Demand Conditions
5. Falling Yield of US 10 Year treasury bond
• Led to increased arbitrage gaps between Indian yield and dollar assets
• Shrunk arbitrage window and fundamentals such as inflation
• Import bill led to rate cut cycle
B. Impact on Economy
1. Short Term
• Benchmark Sensex claimed 728 points,
• Sensex scaled 2 month peak of 28,000
• 50-Share Nifty rose by 2.6%
• Benchmark 10 year bond yield pushed to 7.65%, down 12 basis points
• NSE index rose by 2.5%
• Overnight indexed swap market one year rate fell to 7.50% by 13 bps
• Partial convertible rupee rose to 61.6450
2. Long Term
• Lower Interest Rates, EMIs to lower
• Easier to get home and auto loans at cheaper rates
• Increased consumption, sale of consumer durables
• Rise in consumer demand
• Spurt in investment by corporates
• Banks to cut lending and deposit rates
• Value of bank bond portfolio to rise
• Interest costs will fall
• Corporate loans will be cheaper
• Good market sentiment
• Companies can raise more equity
• Government divestment easy
• Boost in economic growth
• Indian GDP may catch up with China
• Overcoming supply constraints easier
C. Impact on Policy Formation
• Support for government’s fiscal consolidation plan
• Policies for increasing investment
• Policies for boosting infrastructure
• High quality fiscal consolidation
• Reforms in power, land and minerals sector
• Easing cycle starts
• Deeper cuts in case inflation further controlled
• More cuts if fiscal deficit under control
• Onus on government to hold the rate easing cycle
Conclusion
Rate cut’s timing was considered a surprise by financial rating agency Moody’s. Experts termed it a surprise for the markets as well. With far reaching reasons and impacts, RBI’s rate cut has many implications for companies and consumers.
Discussion
- RE: Reasons for Repo rate cut by RBI and impact on economy -Farhana Afreen (01/19/15)
Impacts of repo rate cut by RBI:
Introduction:
On Thursday, the Reserve Bank of India made a surprising move by announcing a 25 basis point cut in repo rate to 7.5 percent. Repo rate is a rate at which the central bank of the country (RBI in case of India) lends money to commercial banks in the event of shortfall of funds. It is also called interest rate. It is one of the method adopted by RBI to control credit in the economy. At inflationary situations central bank increase the rate due to which commercial banks losses the power to borrow, and as a result money flow in the market will be reduced and thus helps in arresting inflation.
Consequences:
1. The move is beneficial to borrowers as they now need to pay less interest on the amount, and detrimental to lenders as they will have to accept interest at reduced rate. It will bring relief to industry along with boosting consumer demands.
2. Interest rate cut by RBI will result in an increase in the borrowing power of commercial banks at low rates from central bank. The credit worthiness will be increased in the hand of banks which will effect more lending at relatively lesser rate. Money in public hands can fulfil limited human wants leading to an increase in demand. Weak demand condition have also moderated inflation.
3. The reduction in the repo rate will make home and auto loans cheaper. Commercial banks are expected to cut their lending rates by 0.10 percent to 0.25 percent. United Bank of India has already announced a reduction in base rate by 0.25 percent from February 1.
4. This will also help in capital formation which ultimately result to savings. As entrepreneur can borrow money from bank at lesser rate of interest for development of plant and industry, it will create capital formation due to which net domestic product increases with increase in national income.
5. Reduction in the rates is a positive development. People will have more money in their hands which will result in an increase in the purchasing power of consumer, ultimately greater spending which is positive for Indian economy.
6. The stock markets, government, and industries will also benefit from this move. The industrialist wants the rate to be lowered to decrease the cost of capital which will give rise to efficiency of production and will help to revive investment cycle that government is trying to restore.
7. This will also help in maintaining uniformity of inflation, which may reduce to some extent. Money flow cycle will also be balanced due to reduction of repo interest rate. This measure will help in improving the relations with the investors.
8. As a result of rate cut, the reverse repo rate, the rate at which central bank drains the excess liquidity from the banking system, also moved down by 25 basis points to 6.75 percent.
9. This is definitely a change welcome by all other sectors but automobile manufacturer are not too happy with 25 basis point rate cut. They were expecting the rate cut off to 50 basis points. Thus automobiles manufacturers are not fully satisfied by the move of RBI.
10. This move will not only affect consumer daily demand but it will also increase the public expenditures which will lead to development of infrastructure and people's standard of living. Increase in public spending will not only takes the nation to growth, but also provide employment to large section of society.
11. These development has provided base for a shift in the money policy stance. Cost of financing has become more stable than before. This will induce banks to offer new home loans at below 10 percent after a gap of around four years, which may act as confidence building move for new buyers.
12. Crude price, barring geo-political shocks, are expected to remain low over the year. Investors should buy long term debt schemes along with more investments in income funds and fixed deposits. More money may chase fixed income product with the fall of interest rate by RBI.
Conclusion:
The Reserve Bank of India cuts its repo interest rate to 7.75 percent as it seemed slowing down of inflation and the government was making efforts to contain the fiscal deficit. The inflation is finally under control which might be the main reason for reviving rate. The EMI's are set to ease a bit. Commercial banks have started lowering the lending rates after cut off in key policy rate by Reserve Bank ok India. Other banks are expected to cut the base rate by March. Share market, government, real estate will also enjoy the reduction of repo rate.
