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RBI cuts repo rate by 25 basis points

The Reserve Bank of India’s (RBI) Monetary Policy Committee has decided to cut the repo rate (short-term lending rate) by 25 basis points, due to receding inflation numbers. Reports expect the repo rate to go down to 6%, which would be lowest rate since 2010.

A cut in rates is expected because as compared to the to global inflation, India’s inflation is regularising and inflation expectation is diminishing along with the reduction in food prices. Additionally, industrial growth remains weak, also contributing to this reduction in rates.

What exactly is repo rate?

This is the rate at which India’s central bank, which is the RBI, lends money to the country’s commercial banks in case there is a shortage of funds. The repo rate is also used to control inflation levels in the country.

Related: 3 reasons why the RBI maintained status quo on repo rates

A major factor that the RBI considers when it comes to deciding the interest rate is retail inflation, which decreased to 1.54% in June 2017, along with the wholesale price inflation decrease to an eight-month low.

It is likely that the RBI will lower lending rates for some segments which have not seen transmission of lower rates as fast as the others. The decision to slash interest rates is aimed at helping to sustain economic growth.

According to analysts, Consumer Price Index (CPI) may remain at comfortable levels, despite the fact that food inflation could increase in the near future, due to a rise in vegetable prices.

Why are repo rates usually cut?

Repo rates are used, as an instrument, by the monetary authorities to control inflation. When inflation rises, the RBI increases repo rates to deter banks from borrowing funds from RBI, thus reducing the supply of money in the economy, and helping to counter hikes in inflation.

Related: The journey of demonetization

The central bank usually does the opposite when there is a fall in inflation. The repo rate is cut when banks borrow money from RBI, and pass on the interest benefit to consumers.

Impact on consumers and economy

A fall in interest rates encourages consumers to be more open to spending more. Loans, in particular, see more interest from consumers. This is especially true when it comes to home loans, which eventually benefits the real estate sector and overall economy.

However, low-interest rates also mean that you get a lower return on your Fixed Deposits (FD) as banks reduce FD rates too. Another benefit of low interest rates is that capital becomes cheaper, allowing companies to expand businesses, which generates more employment and job opportunities.

Related: Decoding Inflation [infographic]

Rate cuts since Jan 2015

Interest rates are being consistently cut by RBI since 2015. In Jan ‘15 the RBI interest rate was 7.75%, which dropped to 7.5% in March ‘15. In June ’17 a further cut of 25 bps was made, reducing the rate to 7.25%, and in Sep ’15 it further dropped by 50 bps to 6.75%. In Apr ’16 it was 6.5%, while Oct ’16 saw it retained at 6.25%.
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