Magazine
Tag:GS-3||Economy|| Banking & Financial Sector||RBI
Why in news?
- The RBI repo rate is reduced by 25 bps to 5.15%, the lowest since March 2010.
- For the fifth time of the year, the Reserve Bank of India’s Monetary Policy Committee (MPC) cut main repo rates as it seeks to improve demand and private consumption amid an economic slowdown.
- The central bank has also reduced the GDP growth outlook for 2019-20 to 1 percent from 6.9 percent in the previous bi-monthly MPC meeting
Key decisions and observations
- Accommodative stance
- The comment by RBI Governor Shaktikanta Das indicated a change from’ neutral’ to ‘accommodative.’
- An’ accommodative ‘ place eradicates the risk of unexpectedly returning to a rate hike.
- This also suggests a greater likelihood of further reductions in the months to come if inflation remained below tolerable limits.
- Growth rate
- GDP growth forecast lowered for current fiscal to 1% from 6.9%.
- The GDP outlook for the year 2020-21 has been revised to 7.2 percent.
- Fiscal deficit
- Government stimulus measures to help strengthen private consumption and spur investments thus reducing the fiscal deficit.
- Repo rate cut
- It is the benchmark interest rate based on which RBI will increase or decrease the money supply in an economy.
- It is charged by RBI on the commercial banks for short term borrowings and when the repo rate increases so commercial banks will borrow less and vice versa.
- Ensuring systemic liquidity seems to remain a key priority for the central bank.
- Across the globe, the major central banks are reducing the repo rates.E.g; US Federal bank
- Digital Transactions
- The RBI has decided to do away with its charges on RTGS/NEFT (Real Time Gross Settlement System/National Electronic Funds Transfer) transactions and will be made round the clock.
- This is welcome provided it can ensure that banks pass on the benefit to customers.
- Punjab & Maharashtra Cooperative Bank (PMC) crises
- RBI has put a cap on the withdraws from the PMC as Rs 1000.
- The reason being the improper maintenance of the books of accounts of the PMC.
- The RBI has highlighted that once such an incident cannot be used to generalize the health of the cooperative banks.
Decision
- Unanimous
- All members of the MPC voted to reduce the repo rateof the system and to maintain the accommodative stance of monetary policy.
- The MPC is made up of six members — three nominated by the Union government and three representing the RBI). The MPC meets every two months to review the monetary policy stance of the RBI.
- Based on Inflation rates
- The MPC is mandated by law to ensure that retail inflation stays within a band of two percentage points of the target inflation rate of 4%.
- Since inflation has been well below the 4% mark, the MPC members have found it logical to repeatedly vote for rate cuts since February.
- Money supply increases when inflation is high so RBI increases the Repo rate to control inflation and does vice versa to increase the inflation.
Impact of the Rate cut
- After the announcement, bond prices dropped and the 10-year yield rose by 80 basis points.
- A decrease in interest rates is beneficial for debt-charged businesses (as it decreases interest costs). The cost of the fund will be lowered for both banks and NBFCs.
- The EMIs (equivalent monthly installments) of lenders are expected to be reduced. In turn, obtaining new loans would be easier.
- Due to a downturn in demand, the auto industry has substantially underperformed the benchmark index over the past few months.
- Some relief would, therefore, be provided by a reduction in the repo rate, while at the same time improving the volume trajectory of rural market players.
- As a result of the cut, companies may be able to borrow at a cheaper rate, resulting in cheaper goods, thereby benefiting the customer.
- Traders will remain apprehensive of more than currently planned government borrowing.
Way ahead
- Given the dovish of the plan, experts predict that interest rates can still be lowered.
- There is a possibility of another 15 to 30bps further cut
- It remains to be seen if such supply-side measures will help achieve the objective of economic recovery.
Conclusion
- The need of the hour is to revive the economy. With regard to future policies, the weak domestic demand conditions and the restricted inflation oath certainly offer space for further change.
Mains model question
- The minutes of the Monetary Policy Committee reveal how its six members read the state of the economy. But is a repo rate cut enough, and how will linking repo rate to lending and deposits rates impact people.
References
