Repo rate is the rate at which the RBI lends money to the banks and is used by monetary authorities to control inflation. In the event of inflation, central banks increase repo rate as this acts as a disincentive for banks to borrow from the central bank. This ultimately reduces the money supply in the economy and thus helps in arresting inflation. Repo rate is considered a benchmark, and any drop in this rate, signals lower interest rates for those who borrow money to buy homes, cars and consumer durables, which in turn boost demand, which makes businessmen confident to ramp up investments in factories. All in all, it is a virtuous cycle.
Interestingly, Raghuram Rajan, since being appointed the Reserve Bank of India (RBI) Governor in August, 2013, had resisted calls for rate cuts and reiterated his view that containing inflation was a prerequisite for the economy.
After repeated calls from Government and business to reduce rates over the past few months to encourage investment, on Thursday 15th Jan 2015, Raghuram Rajan announced his first rate cut and reduced repo rate, by 25 basis points (bps) to 7.75% from the current 8% .This unexpected move came less than three week ahead of the scheduled monetary policy announcement and prompted a near-unanimous opinion that this could be the beginning of a new easing cycle. Following reduction in the repo rate, the reverse repo rate has been adjusted to 6.75 per cent and the marginal standing facility (MSF) rate and Bank Rate to 8.75 per cent. The RBI, however, has decided to keep the cash reserve ratio (CRR), the portion of deposits which the banks are required to have in cash with the central bank, unchanged at 4.0 per cent.
Reasons why RBI Governor Raghuram Rajan cut repo rate by 25 bps:-
- Food prices, particularly those of fruits and vegetables have been easing sharply since September 2014 with a favorable demand supply dynamics ahead. A sharp disinflation in vegetable prices has helped taming CPI and WPI inflation.
- Large fall in global commodity prices has begun to impact a wide range of prices domestically and prices appears benign for the time being.
- Recent surveys has shown that the slowing momentum of prices has begun to push down inflation expectation.
RBI’s announcement led to euphoria in the market – benchmark Sensex gave a thumbs up as it jumped 728 points to scale a two-month peak of 28,000 and the 50-share Nifty too vaulted 2.6 percent, erasing most of its 265-point loss on the same day. The rupee appreciated against the dollar due to gains in equities and yield on the 10-year benchmark bond dropped 7.66 per cent on that day, before closing at 7.70 per cent.
Thus, reduction in the rates is a positive development for the Indian Economy and will help in reviving the investment cycle that the Government seeks to restore. It could bring relief to borrowers as loans might become cheaper as a result of fallout of changes. It signals that India is moving from a prolonged period of consolidation to a growth phase.
What business leaders and policy makers had to say:-
Arun Jaitley, Finance Minister
The rate cut is positive for the Indian economy. It will leave more money in the hands of people for greater spending and help in reviving investment cycle.
Jayant Sinha, Minister of state for finance
The rate cut is a signal of the positive momentum being witnessed on the ground. India is now at a point where the economic indicators point at hope in the future. The rate cut is a lagging indicator of the turnaround in the economy. After trying to take a grip on key factors, the country is now in a phase of accelerating its growth plans.
Soumya Kanti Ghosh, SBI chief economic advisor
This is a positive move by the RBI and is reflective of the impact of the benign environment in commodities and crude. It could be the beginning of a softer interest rate cycle.
Saugata Bhattacharya, Axis Bank chief economist
It is a strong and positive statement from the RBI and would not have been made if the RBI Governor didn’t have conviction in the easing of the inflationary pressures. Now there could be a series of cuts based on the reaction of the markets, banks and the currency. But RBI’s move will be frontloaded, the rate cuts would be done quickly. The next rate cut could likely be in February and it can be estimated that it could be again in the region of 25 basis points. The rate cuts have already strengthened the rupee. The currency has already appreciated and may reach 61.
Shubhada Rao, Yes Bank chief economist
It is a timely move by RBI and is in keeping with the way inflationary pressures have eased. The next rate cut would be contingent on the fiscal consolidation. The next rate cut is expected to be in the first quarter of FY2016, between April and June and will be of 50 basis points.
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