RBI Cuts Repo Rate

The Reserve Bank of India (RBI) in its monetary policy review undertaken by the Monetary Policy Committee (MPC) has made the following decisions:

  • RBI cuts repo rate to 5.4% from the current 5.75%.
  • Reverse repo rate under liquidity adjustment facility stands revised to 5.15%.
  • Marginal standing facility (MSF) rate and the bank rate reduced to 6%.
  • To maintain the ‘accommodative’ stance.

All members of MPC voted to reduce the policy repo rate.

Forecasts Made by MPC

  • GDP growth forecast for 2019-20 lowered to 6.9% from 7% earlier.
  • GDP growth forecast in 1st half of 2019-20 in the range of 5.8 to 6.6%.
  • GDP growth forecast in 2nd half of 2019-20 in the range of 7.3% to 7.5%.
  • Consumer price index (CPI)-based inflation forecast at 3.1% during July-September 2019 and at 3.5-3.7% in October-March 2019-20.

Monetary Policy Committee

The Monetary policy committee is a statutory body established under the provisions of RBI act 1934. The functions of the committee are:

  • The main function of the MPC is to keep the inflation within targets set by the government in consultation with RBI.
  • MPC accomplishes the task by making suitable changes to the policy rate i.e. repo rate.
  • RBI has been vested with the responsibility to publish a document explaining the steps to be taken by it to implement the decisions of the Monetary Policy Committee, including any changes thereto.
  • The meetings of the MPC will be held at least 4 times a year and it will publish its decisions after each such meeting.

Monetary Policy Committee is an executive body of 6 members. Of these, three members are from RBI while three other members are nominated by the Union Government.

The Union government nominates three members to MPC based on the recommendations of a  search cum selection committee consisting of the cabinet secretary (Chairperson), the RBI Governor,  the secretary of the Department of Economic Affairs, Ministry of Finance, and three experts in the field of economics or banking as nominated by the central government.

Significance of a Monetary Policy

For any economy, Gross Domestic Product (GDP) gives the measure of the economic activity. The economic activity in an economy involves:

  • Private individuals and households spending money on consumption.
  • Expenditure of the government.
  • Private sector businesses “invest” in their productive capacity.
  • The net exports which are the difference between what all of them spend on imports as against what they earn from exports.

This spending decision is largely determined based on the cost of money. The RBI is mandated to decide the cost of money, which is more commonly known as the “interest rate” in the economy. RBI’s decision on the repo rate sets the markers for the rest of the economy.

The interest rate decisions are based on the inflation rates since RBI is required to maintain the CPI within 4 +/- 2 per cent. The interest rate decisions also give due consideration to maintain a healthy growth rate in the economy.

Why there is a lag in transmitting the interest rate cut to the customers?

  • The “transmission” of an interest rate cut (or increase) is never a hundred per cent and the consumers may only receive a much lower reduction in the interest rate on their borrowings. This is due to a lot of factors.
  • Over the last few years, almost all banks, especially the ones in the public sector are witnessing plummet in their profits because many of their past loans have turned out to be non-performing assets. As a result, to cover for these losses, the banks have to use their existing funds, which would have otherwise gone to common consumers for fresh loans.
  • Further, the reduced repo rate applies only to new borrowings of banks. The banks’ cost of existing funds is higher. Even though the funding costs would eventually come down but this process would take time.
  • This “lag” in monetary policy is a key variable in determining the efficacy of any rate cut by the RBI. It could take anywhere between 9 and 18 months for the full effect of an RBI decision to reflect in interest rates across the economy.

Impact on Investments

The investments depend essentially on the “real” interest rate which is the difference between the repo rate and retail inflation.

The real interest rate allows an investor to compare the attractiveness of different economies. The real interest rates in India have been rising, and that is one of the biggest reasons why investments are slowing down. The RBI’s move to cut repo rate would reduce the real interest rate and will aid in attracting more investment.

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