Tag Archive : Monetary Policy

RBI Cuts Repo Rate

RBI Cuts Repo Rate by 25bps to 5.75%

RBI Monetary Policy Meet Highlights 6th June 2019

The Reserve Bank of India, RBI cuts repo rate by 25bps to 5.75% from 6% on 6th June 2019. RBI also decided to change the stance of monetary policy to accommodative from neutral and lowered GDP growth forecast to 7% from 7.2%, in its second Bi-monthly monetary policy meet of the financial year 2019-20.

RBI Cuts Repo Rate

On the basis of an assessment of the current and evolving macroeconomic situation, the Monetary Policy Committee (MPC) at its meeting on 6th June 2019 decided to reduce the policy repo rate by 25 basis points to 5.75% from 6% with immediate effect. The MPC also decided to change the stance of monetary policy from neutral to accommodative. These decisions are in consonance with the objective of achieving the medium-term target for consumer price index (CPI) inflation of 4 per cent within a band of +/- 2 per cent, while supporting growth.

KEY HIGHLIGHTS OF RBI BI-MONTHLY MONETARY POLICY MEET

RBI Monetary Policy Meet Key Highlights
RBI Monetary Policy Meet Key Highlights

1. REPO RATE CUT BY 0.25%

  • RBI cuts the repo rate by 25 basis points to 5.75% from 6.0% with immediate effect. Consequently, the reverse repo rate adjusted to 5.50% and the marginal standing facility (MSF) rate and the Bank Rate to 6%.
  • All members of the MPC (Dr. Chetan Ghate, Dr. Pami Dua, Dr. Ravindra H. Dholakia, Dr. Michael Debabrata Patra, Dr. Viral V. Acharya and Shri Shaktikanta Das) unanimously decided to reduce the policy repo rate by 25 basis points.

2. Accomodative Stance of Monetary Policy

  • The Monetary Policy Committee (MPC) also decided to change the stance of monetary policy from neutral to accommodative.
  • MPC has noted that growth impulses have weakened significantly compared to the April 2019 policy. A sharp slowdown in investment activity along with a continuing moderation in private consumption growth is a matter of concern.
  • Thus, RBI sees scope to accommodate growth concerns by supporting efforts to boost demand and reenergize the private investment activity.

3. FORECASTED GDP GROWTH RATE IS REVISED TO 7% FROM 7.2%

  • GDP growth for 2019-20 is revised downwards from 7.2% in the April policy to 7%.
  • It is revised in the range of 6.4-6.7% for H1:2019-20 (April to September FY2019-20) and 7.2-7.5% for H2 (September 2019 to March 2020) – with risks evenly balanced.
  • 6.4-6.7% for Apr-Sept FY2019-20 : Q4 of FY2018-19 has indicated that domestic investment activity has weakened and overall demand has been weighed down partly by slowing exports. Weak global demand due to escalation in trade wars may further impact India’s exports and investment activity.
  • 7.2-7.5% for Sept-Mar FY2019-20 : Because of key positive sides – political stability, high capacity utilisation, the uptick in business expectations in Q2, buoyant stock market conditions and higher financial flows to the commercial sector. These positive sides are promising for good investment activity.

4. Revision in CPI Inflation

  • RBI has revised Consumer Price Index (CPI) inflation forecast for the first half of fiscal year 2019-20 to 3-3.1% from 2.9-3% earlier, while the projection for the second half stands revised to 3.4-3.7% from 3.5-3.8% earlier.
  • The impact of recent policy rate cuts and expectations of a normal monsoon in 2019 are the factors which are taken into consideration by the the MPC for the revision in CPI forecast.

5. TRANSMISSION PROCESS

  • When RBI cuts repo rate, Banks should immediately cut the interest rates of the loans. Interest rates of home loans, vehicle loan or business loans should be come down hand-in-hand.
  • Transmission of the cumulative reduction of 50 bps in the policy repo rate in February and April 2019 was 21 bps to the weighted average lending rate (WALR) on fresh rupee loans.
  • RBI has given a positive signal by repo rates cut. Because it helps enhancing the demand and thereby growing the economy.

6. RBI has removed NEFT & RTGS payment charges

  • RBI has removed NEFT, RTGS payment charges to push digital transactions and has asked banks to pass on benefits to customers. 
  • In order to provide an impetus to digital funds movement, it has been decided to do away with the charges levied by the Reserve Bank for transactions processed in the Real Time Gross Settlement System (RTGS) and National Electronic Funds Transfer (NEFT) systems.
  • Thus, Banks will be required to pass these benefits to their customers. Instructions to banks in this regard will be issued within a week. 

7. POSITIVE IMPACT ON CORPORATE BANKS, AUTO COMPANIES, Real Estate

  • A repo rates cut generally augers well for companies which are debt-laden (as it reduces interest cost), and banks as well as Housing Finance companies as it brings down the cost of funds for them. Thus, Repo rates cut can have a positive impact on the corporate banks such as SBI, ICICI Bank, Axis Bank, Yes Bank etc to increase their profitability.
  • Due to current scenarios liquidity crisis in NBFCs sector such as DHFL and IL&FS, NBFCs are unlikely to get benefited even from repo rate cut. Thus it would offer an added competitive advantage for the banks to increase their profitability.
  • Auto sector would also be one of the key beneficiaries of rate cut. Auto companies, specifically 2 wheeler auto companies such as Bajaj Auto, Hero Moto Cop can be benefited from the repo rates cut by boosting their sales numbers.
  • For the real estate sector, a fall in interest rates could also mean lower EMIs. However, it all depends on the full transmission of the reduction in policy rate to the retail customers by the banks.

SUMMARY

  1. Global economic activity has been losing pace, reflecting further slowdown in trade and manufacturing activity. Crude oil prices are remained volatile and there are many uncertainties surrounding US-China trade negotiations as well as Brexit.
  2. Thus, Monetary Policy Committee (MPC) noted that the output gap remains negative and the domestic economy is facing headwinds, especially on the global front. So there is a need is to strengthen domestic growth impulses by spurring private investment which has remained sluggish.
  3. Against this backdrop, the MPC decided to reduce the policy repo rate by 25 basis and change the stance of monetary policy from neutral to accommodative.
  4. The minutes of the MPC’s meeting will be published by June 20, 2019. The next meeting of the MPC is scheduled during August 5 to 7, 2019.
Reverse Repo Transaction

What is Reverse Repo Rate?

How Does Reverse Repo Rate Work?

Introduction

Reverse Repo Rate is the key instrument of monetary policy of India that is used to control the supply of money in the economy. In this article, we will discuss what is Reverse Repo Rate in detail.

Role of RBI

  • The Reserve Bank of India (RBI), being the central banking institution of the country, plays a pivotal role in the economy. As a Central Bank, Reserve Bank has the responsibility to control the monetary policy of Indian currency and maintain the adequate flow of credit in the economy.
  • Reserve Bank determines how much money is to be made available to the economy and what should be the cost of that money. The availability of money indicates the liquidity position and the interest rate is the cost of using that money (also known as the cost of credit).
  • Maintaining monetary stability in the Indian economy is the prime objective of the Reserve Bank and this is achieved by constant monitoring and stabilization of inflation.
  • There are several financial tools involved in regulating the country’s monetary policy. Reverse Repo Rate is one of such tool used by the RBI to regulate money supply to India’s economic system.

What is Reverse Repo Rate?

  • Reverse Repo rate is the interest rate at which Reserve Bank of India borrows money from the commercial banks by lending securities. This rate is a short term borrowing rate for RBI. If Reserve Bank of India requires to raise money, it approaches commercial banks for borrowing from them at a lucrative Reverse Repo Rate.
  • When banks have excess funds, but don’t have any other lending or investment options, they deposit/lend the surplus funds with the RBI. This way banks can raise additional interest from their funds.
  • In this way, RBI creates an opportunity for financial institutions and commercial banks to generate profit with a short term investment. Current Reverse Repo Rate is 5.75% (May 2019)
  • Reverse Repo Rate is the functionally opposite concept to Repo Rate which works hand in hand to maintain the financial stability of our banking system and aid the growth of the economy.  
Reverse Repo Rate
Reverse Repo Rate

How Does Reverse Repo Rate Work?

  • Reverse Repo Rate is used to control the money supply in the system. Sometimes there will be surplus money in the market, which is a situation typically happens at the time of inflations. This results in the rise in price of all commodities and services resulting in the devaluation of money. In such situations, Central Bank will increase Reverse Repo Rate to discourage the Banks to lend money. Reserve Bank of India will take control of the economy using the various instruments like modifying the Reverse Repo Rate. Reverse Repo Rate enables RBI to absorb liquidity from the economy.
  • An increased Reverse Repo Rate will reduce the money supply in the system, other factors remaining constant. If Banks have disposable funds that are remaining idle without deposit or investment opportunity, they can deposit such funds for a short term and earn interest. The interest rate that Reserve Bank will give the commercial banks for borrowing money from the banks is the Reverse Repo Rate.  
  • If Reserve Bank of India wants to restrict the availability of money in the system, they can increase the Reserve Repo Rate. This will provide incentive to the commercial banks to park more money with RBI resulting in less availability of the cash in the banking system and hence in the economy.
  • Commercial banks will prefer to deposit their surplus with RBI for a short term since it is a completely risk free as compared to other riskier investments such as lending. Banks will be short of fund to provide credit to individual or institutional borrowers. This in turn will restrict the liquidity in the market.  
  • Due to reduced liquidity, the lending rates of commercial banks will go up leading to reduced demand for funds. This effect has the potential to control the market inflation. Also, from the perspective of commercial banks, if they have less funds available, they will be less involved in risky credit disbursement. So, increased Reverse Repo Rate provides some protection to the bank from credit risk.
  • On the contrary, if Reverse Repo Rate is reduced, RBI gives an indication to the banks not to deposit their surplus funds with Reserve Bank any more. In such situation, banks will be more inclined to commercial lending to consumers at a cheaper interest rate. This will inject more liquidity in the system resulting in greater cash flow in the market.

Significance of Reverse Repo

1.Liquidity Regulator

  • Reserve Bank of India has a framework for surplus funds/cash in the banking system which ensures there is no excess liquidity in the system. And this framework is referred to as reverse repo.
  • Basically, repo transactions inject liquidity into the Indian banking system. On the other hand, reverse repo absorbs liquidity from the Indian banking system.
  • The reverse repo rate has an inverse relationship with the money supply in the economy.
  • During high levels of inflation in the economy, the RBI increases the reverse repo. It encourages the banks to park more funds with the RBI to earn higher returns on idle cash. As a result, every excess rupee is put to use in banking system. Banks are left with lesser cash to extend loans, curbing the purchasing power of individuals.

2.Price Stabilizer

  • RBI has to control the rate of inflation, supply of money in the economy and stimulate the economic growth. Thus, RBI has to strike a balance between both inflation, money supply and economic growth by revising the repo & reverse repo rate on a half yearly or quarterly basis.
  • It is important for the country’s economic growth. And it’s equally important to avoid the higher rate of inflation in the country. This is where repo rate and reverse repo rate plays a crucial role by helping Reserve Bank of India strike a balance between both inflation and economic growth.

India’s Reverse Repo Rate Trend

Current Reverse Repo Rate is 5.75%, whereas the current Repo Rate is 6% as per the recent announcement in (April 2019) Bi-Monthly Monetary Policy by Monetary Policy Committee.


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