Repo rate cut and change in policy stance in RBI’s bi-monthly review

What came out of the RBI MPC’s latest bi-monthly policy review meeting and what are the reasons and implications behind it

Repo rate cut and change in policy stance in RBI’s bi-monthly review

The repo rate went down by 25 basis points and has presently settled at 5.75%. The Monetary Policy Committee of the Reserve Bank of India took this decision in its bi-monthly policy review on Thursday (June 6). The RBI confirmed that the decision was unanimous. They also changed the policy stance from “neutral” to “accommodative”. The committee has, however, kept the Cash Reserve Ratio unchanged at 4%.

Repo rate is the rate at which the RBI lends to the commercial bankers. If the latter passes on the benefit to the corporates and retail borrowers, the rate of interest should fall as a response to the cut in repo rate. But banks may not have been very diligent in passing it on.

Related: Banks to cut interest rates on savings accounts. What does that mean for you? 

These decisions have come on expected lines, as explained by market experts. The rate cut and the changed stance is aimed to address the slowdown in the economy, while the rate cut can also improve the liquidity. In fact, more actions to improve the liquidity can be expected on the days to come.

The MPC noted a slowdown in growth in general and investment activity, apart from continuing moderation in private consumption growth. Escalated trade wars have weakened global demand which, in turn, has led to slow private investment activity and may affect exports. The MPC identifies the scope to accommodate growth and reignite private investment activity while keeping the flexible inflation target. Factors like political stability, higher capacity utilisation and upbeat stock market can lead to a late surge.

India’s retail inflation has remained at 2.9%, below the RBI’s mandated target of 4%, which along with the low growth rate has led to the rate cut. However, the rate cut hasn’t had any immediate impact to speak of. The Sensex and Nifty declined after the announcement while 10-year sovereign bond yield rate also fell.

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How does the repo rate impact economy?

The use of repo rate to influence the inflation and economy, in general, is known as a transmission mechanism. Repo rate, at least in theory, is directly proportional to the market interest rate. Market interest rate increases or decreases with respect to any increase or decrease in the repo rate. But apart from the interest rate, the repo rate also affects the exchange rate of the currency. An increase in the exchange rate increases the exchange rate, leading to an increase in imports and a decrease in exports. 

What is the present state of growth of the Indian economy?

The growth rate in the Indian economy is at a slow period. We have registered a 5.8% growth in this year’s January – March period, the lowest in five years. This is also reflected in the fixed investment growth rate of a paltry 3.6% for the same period. There is a slump in private consumption, particularly in rural areas, while investment activity, too, is slow.

Related: 5 reasons watching the finance channel can make you rich 

How can the RBI influence the economy?

The Monetary Policy Committee of the RBI has macroeconomic targets surrounding inflation, consumption, growth and liquidity. Money policy is a macroeconomic tool in itself that manages the money supply, interest rates and acts as a demand-side economic policy. The RBI uses its monetary policy to achieve inflation targets, stabilise the exchange rate and power the growth rate of the country. 

The accommodative policy stance, as mentioned above, tries to influence market sentiment and appreciate riskier assets because these can help the growth momentum and increase the GDP growth rate. Have a look at 3 reasons why the RBI maintained status quo on repo rates.

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