The Reserve Bank of India or RBI is expected to cut the repo rate by at least 25 basis points on June 6th. For the record 1 basis point is 0.01%. The repo rate currently stands at 6%. The RBI reduced the repo rate from 6.5% to 6.25% in the February Monetary Policy Review meet and to 6% in the April Monetary Policy Review meet.
The repo rate is the rate at which RBI lends to commercial banks. RBI uses the repo rate to keep inflation under control. When RBI cuts repo rate, the banks are expected to pass on this benefit to customers through lower interest rates on loans. Banks would cut MCLR which is the lowest rate at which banks lend. (MCLR is the benchmark lending rate at which banks lend to new borrowers).
When you avail a loan from the bank, you are charged interest on the principal borrowed. This is cost of credit or in simple language, the cost of borrowing. In much the same way, banks borrow from the RBI when they face a cash crunch. The interest they pay is the repo rate.
In simple terms repo is called the ‘repurchase option’. Banks offer eligible securities like treasury bills to the RBI when taking overnight loans. The eligible securities would be bought back at a predetermined price.
See Also: Repo Rate vs Bank Rate
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Yes, the RBI has cut the repo rate by 25 basis points to boost growth in the economy. The repo rate is 5.75%. This is in-line with what most banks had expected.
The RBI didn’t have much of a choice and had to cut the repo rate. The GDP growth had slipped to 5.8% in Q4 and stood at 6.8% for the entire FY 2019, which was a 5-year low. The new Finance Minister Nirmala Sitharaman has a two-fold task on her hands:
This brings the question, why did RBI cut interest rates? The RBI has set the inflation target between 2-6% and not 3-4%. The CPI or Consumer Price Index which measures retail inflation was 2.92% for the month of April. With inflation on the lower-side and growth desperately needing a boost, the RBI was forced to cut the repo rate.
The RBI has cut the repo rate by 25 bps from 6% to 5.75%. It has also changed the policy stance from ‘neutral’ to ‘accomodative’. An accommodative stance means more rate cuts could follow.
See Also: Impact Of Increasing Repo Rates
Banks are laden with bad debt and could lose customers if they cut deposit rates. This would restrict ability to lend. Banks are not getting sufficient deposits and this is the reason why they are reluctant to transmit repo rate cuts to customers. If banks cut deposit rates, customers would shift investments to small saving schemes like NSC or PPF which offer high returns.
NBFCs are facing a liquidity crisis after the IL&FS fiasco and also Crisil downgraded DHFL commercial paper to D from A4+. With many NBFCs in the midst of a liquidity crunch, India’s shadow banking is in a crisis.
So how can repo rate cut propel banks to lend? Frankly speaking, the 25 basis point repo rate cut doesn’t make much of a difference to banks. Banks are looking at the stance. RBI has changed its stance from “neutral” to “accommodative”. This means more rate cuts could follow increasing banks appetite to lend.
The RBI has cut repo rate to 5.75% and this begs the question: How to invest with a repo rate cut? The first thing to do: Look at rate sensitive stocks:
A repo rate cut is good for debt funds which invest in long term bonds. This is because when bond yield falls, prices rise and vice versa. When RBI cuts repo rate, debt funds which invest in long term bonds perform well, seeing a rise in NAV.
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