RBI just made life easier

The RBI Governor on Tuesday kept policy rate unchanged, awaiting clarity on impact of unseasonal rains on food inflation even as he wanted banks to pass on benefits of previous two rate cuts.

The repo rate, at which RBI lends to the banking system, will continue to be at 7.5% and the cash reserve ratio, which is the amount of deposits parked with the central bank, will remain at 4%.

“Transmission of policy rates to lending rates has not taken place so far despite weak credit off take and front loading of two rate cuts. With little transmission, and the possibility that incoming data will provide more clarity on the balance of risks on inflation, the Reserve Bank will maintain status quo,” he said in the first bi-monthly policy review for 2015-16.

Rajan, who has surprised with two rate cuts of 0.25% each outside the scheduled review meetings this year, however, affirmed his commitment to the accommodative stance, but added that policy moves will be shaped by incoming data and added that transmission of rate cuts by banks will be his top-most priority.

Apart from the transmission, other factors like food prices will also be monitored closely, he said, adding that the impact of the recent unseasonal rains will also be monitored closely.

“Reserve Bank stays vigilant to any threats to the disinflation that is underway,” he said, expecting that the price rise situation has so far faired according to its estimates.

“The Monetary Policy Framework Agreement signed by the Government of India and the Reserve Bank in February 2015 will shape the stance of monetary policy in 2015-16 and succeeding years. The Reserve Bank will stay focussed on ensuring that the economy disinflates gradually and durably, with CPI inflation targeted at 6% by January 2016 and at 4% by the end of 2017-18,” RBI said.

In January and March, RBI cut the repo rate by 25 bps each but that hasn’t trickled down, barring some state-owned banks. A basis point is one-hundredth of a percentage point. A 50 bps CRR cut would free up about Rs 43,000 crore funds, adding to liquidity in the banking system.

According to Rajan, it takes three or four quarters for RBI’s rate action to be transmitted through to the banks. This would mean lenders should be reducing rates by October, when loans are seen starting to pick up.

Rajan had cut repo rate by 25 bps in March, on the back of lower inflation and Rajan’s thumbs up to measures announced by Finance Minister Arun Jaitley in Budget 2015.

Rajan had explained in March: “The need to act outside the policy review cycle is prompted by two factors: First, while the next bi-monthly policy statement will be issued on April 7, 2015 the still weak state of certain sectors of the economy as well as the global trend towards easing suggests that any policy action should be anticipatory once sufficient data support the policy stance.

“Second: With the release of the agreement on the monetary policy framework, for the Reserve Bank to offer guidance on how it will implement the mandate.”

RBI is of the opinion that softer readings on inflation are expected to come in through the first half of 2015-16 before firming up to below 6% in the second half.

On the GDP growth, RBI estimated a 7.8% expansion in the current fiscal, stating that uncertainties on the arrival of monsoon and unanticipated global developments are major risk areas.

 

Understanding repo rate and CRR

The rate at which the Reserve Bank of India lends money to commercial banks is known as the repo rate, while CRR is the portion of bank deposits that all commercial banks have to deposit with RBI.

 

How increase in repo rate will affect common man?

Banks offer loans like home loans and auto loans to someone at an interest rate which is directly proportional to Repo rate. Now if there is an increase in repo rate, this will directly be passed to a common man.

Interest rate for common man will be repo rate plus the rate of interest on which he took the loan from the bank.

So, if repo rate increases, the interest rate of the loan will also increase, thus increasing the EMI.

 

But what if repo rate decreases?

Although inflation was a deterrent, cut in repo rate is good news as it is likely to lower the cost of borrowing for both individuals and corporates. The reduction in CRR is likely to improve the availability of funds bringing in more liquidity to the system.

The CRR cut is also likely to have a long-term impact on the interest rates on deposits. Repo rate and CRR cut may bring down home and auto loans.

 (With inputs from PTI)