Thursday morning came with a surprise from Reserve Bank of India Governor Raghuram Rajan with a cut in Repo Rate by 25 basis points. Rate has decreased from 8% to 7.75% with immediate effect. The long awaited repo rate cut is welcomed as this is the first cut since 2013.

Repo Rate is cut by 25bps – what does it mean for the economy . 

To understand this action of the RBI and its implication on the economy and common people, let us know about repo rate.

The rate at which the Reserve Bank of India(RBI) lends money to commercial banks against the pledge of government securities in the event of any shortfall of funds is Repo Rate.  In the event of inflation, RBI increase repo rate as this acts as a disincentive for banks to borrow from the central bank. This ultimately reduces the money supply in the economy and thus helps in controlling inflation. To temporarily expand the money supply, the central bank decreases repo rates through which banks can swap their holdings of government securities for cash. The RBI revises CRR and Repo Rate in their quarterly and mid- quarter policy to maintain a balance between growth and inflation.

Cut in repo rate will help to spur growth. With the cut in repo rate the cost of borrowing will be lowered for both individuals and corporate though not to the same extent as the cut in the repo rate. This in turn will impact common people. If we talk about the industrial projects, then the long term loan taken at higher rate will be viable to some extent and the projects can regain the speed.

In  real estate and infrastructure sectors, contraction of repo rate will prove to be boon. It will help the promoters to provide estates at a discounting rate and investors can also invest higher amount. With the same income, a higher loan will be sanctioned and at the same time EMI will be lowered through which people will have better options for them. Assuming the interest rate on a 20 year housing loan of Rs 75 Lakh is decreased from 11.25 to 11 %, it will translate into an decrease of approximately Rs 1279 per month in the EMI.

Though this move of RBI was expected in Feb or after the budget but the aggressive downfall in rates was needed to help the Indian economy to groove. Lower than expected inflation as we have also mentioned in our article just one day before this announcement has been the basis for this decrease. Expectations of market were cut of 50-75 basis points. But a small fall has given a sphere for more reduction in future.

In the banking sector, this cut will lead to high liquidity.  Depending on the liquidity condition of the banks, the new interest and deposit rates may be passed on once banks analyze their cost of funds. However, due to high slippages, credit costs for banks have considerably been raised. Therefore, they may not be able to give full effect of repo rate reduction to the consumers. If this will be the situation then this small fall will turn smaller for borrowers.

The cash reserve ratio (CRR) has been kept unchanged at 4% of net demand and time liabilities (NDTL) while the reverse repo rate stands adjusted to 6.75%.

As inflation showing some stability and the crude prices are decreasing, more fall of repo rate is expected in this fiscal year. With wholesale inflation at 0.11% in December and retail inflation at 5%, the RBI has the room to give more cheer to the market in the coming days.