RBI repo, CRR rate cuts decoded; what does it mean for you

Moneycontrol Bureau

Here are a few frequently asked questions about the Reserve Bank of India's monetary policy. Team Moneycontrol has attempted to simplify some of the jargons and explain the implications of the policy:

1. What did the RBI do in its monetary policy review today?

It has cut repo rate—the rate at which it lends to banks—by 25 basis points to 7.75 percent and the cash reserve ratio—the portion of deposits that banks have to compulsorily keep with the RBI—by 25 basis points to 4 percent.

2. Were the measures on expected lines?

Largely. The stock and bond markets had taken for granted a 25 basis point-cut in repo rate. The market had been expecting a 50 basis point-cut till about a week back. But the expectations were tempered by the RBI’s cautious outlook in its macroeconomic report released on Monday.

3. Why did the RBI cut cash reserve ratio as well?

Banks had said that repo rate cut in the absence of CRR cut would not give them much room to cut lending rates. By cutting CRR, the RBI will infuse around Rs 18,000 crore into the system (which otherwise would have been locked up with RBI) and give banks more leeway to pass on the reduction in policy rate to their customers.

4. Will the repo rate cut automatically lead to banks lowering their loan rates?

May or may not. That is because deposit growth has been weak. If banks have to cut their lending rates, they will have to cut deposit rates as well to maintain profitability. Cutting deposit rates at a time when inflation is high could further alienate savers, making it difficult for banks to growth their deposit base.

5. Does this mean that banks will not cut rates at all?

Banks may cut rates, but the cuts could be selective. Remains to be seen if banks will reduce their base rates, to which all their other rates are linked. In the past, banks have reduced interest rates on certain maturities, without revising their base rates.

6. RBI has lowered its current year inflation forecast to 6.8 percent from 7.5 percent. Is the worst of inflation behind us?

Not necessarily. Demand pressure has eased somewhat, but supply side (output) issues remain. Unless those are fixed, inflation could rise again. Also, food inflation, diesel price hikes over the next several months and the possibility of adjustment in other subsidised prices could keep inflation rangebound.

7. Have we entered a declining interest rate environment?

Hard to say. Populist but reckless fiscal policies ahead of the 2014 elections could render RBI’s monetary policy ineffective. Also, India’s widening current account deficit (dollars flowing in minus dollars flowing out) is a major concern. Unless exports pick up in a big way, India will be dependent on volatile foreign portfolio flows to bridge the CAD. Fresh trouble in the US and Eurozone could make global investors risk averse, and choke capital flows. This in turn could weaken the rupee, and threaten macroeconomic and exchange rate stability.

8. Will lower interest rates alone be good enough to revive economic growth?

No.  To boost growth, the investment cycle has to be revived. There are not enough new projects coming up, as the RBI has cautioned. A number of factors such as bridging the infrastructure gaps, hastening approvals, removing procedural bottlenecks, and improving governance, are required to spur investment.

Also Read: RBI cuts repo, CRR by 25 bps; will banks respond in kind?