In the first bi-monthly monetary policy meeting of this fiscal year, the Reserve Bank of India took immediate action on the government’s strongly expressed demand for rate cuts. The policy Repo Rate was cut down by 25 basis points which brought it down to 6.50 percent, the lowest since January 2011. The Cash Reserve Ratio (CRR) remains unchanged and the Statutory Liquidity Ratio (SLR) of ‘scheduled banks’ has been lowered from 21.5% to 21.25%.
To get a better understanding of these rate cuts, we need to take a closer look at the definition of these terms.
Repo Rate- It is the rate at which the RBI lends money to the commercial banks when they fall short of funds. Decreasing the repo rate is incentivising borrowing for commercial banks so that there can be a higher supply of money in the economy. It is a part of the government’s liquidity adjustment facility.
Cash Reserve Ratio (CRR)- Out of the total deposits of the customers, banks have to hold a specified minimum fraction as reserves in the form of deposits with the RBI or as cash. This is also a tool of controlling money supply in the economy.
Statutory Liquidity Ratio (SLR)- Apart from CRR, banks also have to maintain a fraction of their net demand and time liabilities (NDTL) in the form of liquid assets like gold, encumbered securities and cash. It is a tool of market stabilization.
The changes in these rates are governed by the rate of inflation in the country. At this point of time, inflation is showing a downward trajectory and these decision acted as a follow up of the government’s fiscal consolidation targets announced in the Union Budget 2016. This has been the first rate cut in India after September and it was a clarion call of the government as well as the consumers. As per February publish, consumer inflation stood at 5.18%.
In a post-meet press conference, RBI Governor Raghuram Rajan stated- “Further monetary policy decisions will be driven by outcome of the monsoon, monetary policy transmission, trajectory of core inflation.” This means that the policies are open to further rate cuts depending on several macroeconomic factors.
The idea behind this rate cut is to allow more money flow in the economy and encouraging banks to pass on the benefits of rate cuts to their customers (borrowers). This was possible because of the government’s take on reducing the cost of key saving instruments in the Union Budget and its consolidation targets. The RBI also aims at bringing down the consumer inflation rate to 5% by the end of this financial year.
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