RBI cuts repo rate by 25 basis points, all eyes now on banks

The Reserve Bank of India on Tuesday cut repo rates by 25 basis points, signalling its belief that prices of goods in the country are moderating and, more importantly, supporting the government’s measures to encourage industry and the common man through cheaper loans.

At the first bi-monthly monetary policy for the fiscal year 2016-17, RBI governor Raghuram Rajan reduced the repo rate to 6.50% from 6.75%, the first reduction since September last year.

Repo rate is the rate of interest at which banks borrow from the RBI. The bank rate, which is aligned to the marginal standing facility rate, also stands adjusted to 7.0%. With the repo rate cut, focus will now shift to how soon and to what extent the commercial banks pass on this benefit to the retail and corporate consumer.

So far, banks have been slow in passing on previous rate cuts by RBI. However with a change in methodology in calculating rates from April 1, as stipulated by RBI, it is widely expected that banks will be able to transmit faster changes in interest rates.

The RBI governor has in the past raised concerns that policy rate cuts were not being passed on, and pointed out that of the 125 bps cuts that had been effected since he took over, only some 60 bps had been passed on by banks.

“Inflation has evolved along the projected trajectory, and the target set for January 2016 was met with a marginal undershoot. Going forward, CPI inflation is expected to decelerate modestly and remain around 5% during 2016-17 with small inter-quarter variations,” the RBI announcement on Tuesday said.

“There are uncertainties surrounding this inflation path emanating from recent unseasonal rains, the likely spatial and temporal distribution of monsoon, the low reservoir levels by historical averages, and the strength of the recent upturn in commodity prices, especially oil. The persistence of inflation in certain services warrants watching, while the implementation of the 7th Central Pay Commission awards will impart an upside to the baseline through direct and indirect effects,” it said.

The central bank also said there would be “some offsetting downside pressures stemming from tepid demand in the global economy, government’s effective supply side measures keeping a check on food prices, and the central government’s commendable commitment to fiscal consolidation.”

With inflation falling to 5.2% in February compared to 5.7% in the previous month and the government keeping its part of the bargain by controlling borrowing and expenditure in the Budget, there was space for RBI to cut rates, which is also expected to improve business sentiment.

Industrial growth was down 1.5%, posting a negative trend for the third consecutive month; a rate cut will encourage businesses to borrow and expand, fuelling growth, it is expected.

Retail inflation measured by the consumer price index dropped sharply in February after rising for six consecutive months. This was due to a larger-than-anticipated decline in vegetable prices, helped by prices of pulses starting to come off the surge that began in August, and effective supply management that helped limit cereal price increases.

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