RBI Repo Rate: The Good, the Bad, and the Ugly

With the release of the minutes of the meeting held on December 6th and December 7th delivered by the Reserve Bank of India throws light on a couple of interesting insights into the decision  made by the Monetary Policy Committee (MPC) to not change the repo rate. It was a unanimous decision made by the 6 member team of the MPC which decided to keep the repo rate which comes under the Liquidity Adjustment Facility (LAF) unchanged which currently stands at 6.25%. Following this, the reverse repo rate also saw a dip in numbers which came down to 5.75%. This move is said to promote the reduction of lending rates by banks which provide loans for housing, personal loans, corporate borrowers, and car loans. With the announcement made by Prime Minister Narendra Modi to get rid of higher denomination notes or specific banknotes (SBN), banks saw an influx of demonetised notes flooding their vaults. This created a lot of liquidity. This, coupled with the recent cut in repo rates that amounts to 175 bps could cause a significant chance for the inflation rate to exceed the threshold in March 2017. Apart from showing concerns about inflation, the main theme was the lack of transferral of the repo rate cuts to the credit market.

Ignoring the transfer repo rates

With liquidity available at their disposal, banks are being quite hesitant in lending out money to various sectors. Banks have begun to cultivate the habit of asking for reduction in repo rates while transmitting none of the repo rate cuts which has been previously offered. Raghuram Rajan, the 23rd Governor of the Reserve Bank of India, pointed out in a statement made on the 9th of August, 2016, that this was beginning to be a subject of concern. Repo rates are rates imposed on the money that has been lent out to a bank from the RBI.

MCLR of banks to see changes

Loans such as home loans, personal loans, farm loans, etc., that have been applied for and taken after the 1st of April, 2016, are associated with the marginal cost of funds based lending rate (MCLR) while those prior to this date are associated to the bank’s base rate. Loans applied before the 1st of April, 2016, have the option change to MCLR rates. 

Uncharted roads ahead

Recognizing the lack in transfer of incentives by banks, the Government and the RBI have taken up the initiative to provide better incentives to banks which would promote the transmission of these incentives. Banks are now being expected to become more proactive in slashing lending rates rather than asking for more cuts in repo rates. But, with the sudden withdrawal of SBN’s, all plans made by banks have now been thrown into a fix.

With no sight of the horizon, a lot of questions go unanswered when it comes to cutting repo rates. A ‘wait and watch’ policy is being followed at the moment as any decision to cut repo rates further have currently been put on hold.