Related Topics: Monetary Policy Committee, Repo Rate, Reverse Repo Rate
- The six-member RBI Monetary Policy Committee has decided to cut interest rates by 25 basis points (bps) to 5.1%.
- This is the fifth consecutive rate cut by the apex bank in 2019, aggregating to 135 bps.
Highlights of RBI Monetary Policy Statement
- RBI has lowered its Repo rate—the rate at which banks borrow from it—by 25 basis points to 5.15%.
- Consequently, the Reverse Repo rate under the LAF was reduced to 4.90 per cent, and the Marginal Standing Facility (MSF) rate and the Bank Rate to 5.40 per cent.
- The central bank will continue with an accommodative stance as long as it is necessary to revive growth, while ensuring that inflation remains within the target.
- RBI has revised real GDP growth for 2019-20 from 6.9% to 6.1%, with the committee noting that the negative output gap has widened further.
- Growth forecast for the first quarter of the next financial year was also trimmed to 7.2% from 7.4%.
- Inflation forecast for the second half of FY20 has been retained at 3.5-3.7%.
- These decisions are in consonance with the objective of achieving the medium-term target for Consumer Price Index (CPI) inflation of 4 per cent within a band of /- 2 per cent, while supporting growth.
- In order to allow a wider range of recipients to be covered by this mode of financial inclusion, RBI has raised the lending cap for microfinance institutions to ₹1.25 lakh from ₹1 lakh.
Why RBI is cutting Repo Rate?
- The rate cut comes after GDP growth for the first quarter of the current financial year plunged to a 25-quarter low of 5%.
- While cutting the GDP growth projection, the RBI reasoned that domestic demand conditions remained weak and export prospects were being impacted by slowing global growth and continuing trade tensions.
- The move is aimed at kick starting the investment cycle, stimulate demand and increase liquidity in the economy.
- A rate cut usually helps companies or stocks that are highly leveraged as well as banks and NBFCs.
- It will help companies with lower interest payments and lower EMI for borrowers, if the banks pass on the benefit to customers.
- With banks linking floating loans for retail and micro and small enterprise segments to the repo rate with effect from October 1, 2019, lending rates for new borrowers in these two segments are expected to come down further.
- A rate cut would bring down the cost of funds, help in recovering credit growth, and also help improve the quality of assets, leading to a decline in NPAs.
- It would help revive growth and bring financial stability among the banks.
- Any rate cut by RBI along with other measures to transfer the benefit to end-users will help the liquidity issues of interest rate-sensitive sectors like automobiles, real estate, and consumer durables and will help to revive the declining demand.
- While a reduction in lending rates in the economy will clearly benefit loan takers, it hits those living off income from fixed deposits when the rates on these go down.
Will lower rates spur economic growth?
- Capital is one of the three main factors of production, which are critical to the growth of a commercial entity, the other two being land and labour.
- Here, Capital is only a necessary, not a sufficient condition.
- Land, unless allocated by the local government, is too costly for investors seeking to set up shop.
- On labour, even if adequate hands are available for a job, the skill quotient is still low.
- Training graduates to be job-ready is a form of tax that companies pay.
- Market environment and demand is also to be taken into account, for growth of economy in a country.
- If end users are seeing lesser money in hand than earlier, demand will certainly be impacted.
- Therefore, in an environment where the other factors of production are not favourable for an investor, low interest rates by themselves may not prove attractive enough.
- Any revival of economic activity will be contingent on joint efforts by the government on the fiscal front to stimulate demand, and the RBI, to keep interest rates low.
[Source: The Hindu, Livemint]