Consistent with its neutral stance, the Reserve Bank of India (RBI) reduced the repo rate by 25 basis point to a six and a half year low of 6 percent on Wednesday.
The monetary policy committee (MPC) came to this decision keeping in mind to its objective to achieve medium-term target for consumer price index (CPI) inflation of 4 percent, within the error range of +/- 2 percent, while supporting growth at the same time, RBI said in a statement.
Despite the monetary easing the question still remains whether it will be passed on to the end consumer or not?
In the press brief post the policy announcement, deputy governor Viral Acharya raised concern on this issue said, "The experience with the Marginal Cost of Funds Based Lending Rate [MCLR] system introduced in April 2016 for improving the monetary transmission has not been entirely satisfactory. even though it has been an advance over the Base Rate system."RBI Credit Policy: How Interest Rates Work
MCLR replaced the base lending rate in 2016 and was aimed at enabling the transmission of monetary easing to the end customer.
Since the easing cycle started back in 2015, under Raghuram Rajan, the RBI has reduced the repo rate by 200 basis points till date.
However, experts believe that much of the 2 percentage point rate cut has not been transmitted into lower lending rates by banks. This has been criticized by the current governor, Urijit Patel as well.
When the central bank had last reduced the repo rate back in October 2016, RBI chief Urjit Patel said that the transmission to bank lending and to bank borrowers had been "less than any one of us would have liked".
In the graph below, which compares the SBI base rate trend against the RBI repo rate, one can see that since 2015, the RBI has reduced its rates by 200 bps whereas SBI reduced its base rate (now MCLR) by 100 bps to 9 percent.
"An internal Study Group has been constituted by the Reserve Bank of India (RBI) to study the various aspects of the MCLR system from the perspective of improving the monetary transmission and exploring linking of the bank lending rates directly to market determined benchmarks," Acharya said.
This group is tasked to submit its report by September 24, 2017.
Retail borrowers who have taken loans on floating interest rates are directly impacted by the RBI's monetary easing or tightening.
A huge portfolio of customers are still on the base lending rate and those took loans since April 2016 are on MCLR, hence many are not receiving the benefits of the monetary easing.
In March, the Financial Express reported that the migration to MCLR regime from the older base rate regime constituted less than 20 percent of the overall loan book at most large banks.
"Given a large part of the floating rate loan portfolio of banks is still anchored on the Base Rate, the RBI will be exploring various options in the near future to make the Base Rate more responsive to changes in cost of funds of banks," Acharya said.Follow @shukla_05sid