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Repo rate cut – Will it Uplift the Economy

Repo rate cut – Will it Uplift the Economy

The repo rates were cut by another 40 bps from 4.40% to 4.00%.

  • This is the lowest repo rate that the RBI has ever maintained in India.
  • As a result, the reverse repo rate stands reduced from 3.75% to 3.35%, the idea being to leave banks with little incentive to park funds with RBI.
  • This resulted in the bank rate and the marginal standing facility (MSF) also standing reduced from 4.65% to 4.25%.
  • The six members of the Monetary Policy Committee (MPC) voted unanimously for an accommodative stance and they voted 5:1 in favour of cutting rates by 40 bps.

Other policy measures:

  • RBI had announced a 90-day special Rs.15,000 crore refinancing facility to SIDBI for on-lending to small industries.
  • That tenure stands extended to 180 days.
  • Tenure of pre and post shipment credit to exporters enhanced from 12 months to 15 months. EXIM Bank also gets liquidity support.
  • The time period for the EMI moratorium for corporate and retail borrowers has been extended by 3 months till August 31st 2020.
  • RBI has also allowed further deferment of interest on working capital by 3 months but has been silent on the one-time restructuring demand of industry.
  • State governments can use the balance in the consolidated sinking fund (CSF) to handle redemption of market borrowings in order to reduce stress.

Will this rate cut really boost credit growth?

  • Credit pick up has to be driven by retail or corporate demand.
  • In the case of corporates, the macro environment is still unclear and most businesses are putting their capital investment plans on hold.
  • In terms of retail demand, the risk aversion is still quite high and most households are facing the pressure of job losses / income cuts. Under these circumstances there is limited visibility of growth.
  • The 40 bps cut in repo rates may have limited the policy options for the RBI. After the 75 bps cut in March, a bigger fiscal thrust may have worked better.

What is Repo rate?

  • Repo rate is the rate at which the central bank of a country (Reserve Bank of India in case of India) lends money to commercial banks in the event of any shortfall of funds.
  • Repo rate is used by monetary authorities to control inflation.
  • It may also be used to increase demand in the economy.

What is Reverse repo rate?

It is the rate at which the central bank of a country (Reserve Bank of India in case of India) borrows money from commercial banks within the country. It is a monetary policy instrument which can be used to control the money supply in the country.

What is Marginal standing facility (MSF)?

It is a window for banks to borrow from the Reserve Bank of India in an emergency situation when inter-bank liquidity dries up completely. Banks borrow from the central bank by pledging government securities at a rate higher than the repo rate under liquidity adjustment facility.

What is Bank rate?

  • It is the rate charged by the central bank for lending funds to commercial banks.
  • Bank rates influence lending rates of commercial banks.
  • Bank rate usually deals with loans, whereas, repo or repurchase rate deals with the securities.

What is Consolidated sinking fund?

  • CSF is a reserve fund mainly for amortisation of debt.
  • It was set up in 1999-2000 by the RBI to meet redemption of market loans of the States.
  • This is one of the buffers available to the state governments for servicing their liabilities.
  • It is a fund through which some financial discipline is being insured.

EXIM bank (Export and Import:

  • To provide financial assistance to exporters and importers.
  • To function as the principal financial institution for coordinating the working of institutions engaged in financing export and import of goods and services with a view to promoting the country’s international trade.

Monetary Policy

  • Monetary policy refers to the policies formulated for the purpose of controlling monetary supply and rate of interest/cost of money in the economy to stimulate the growth.

MPC:

  • The Monetary Policy Committee (MPC) is formed under the RBI with six members.
  • Three of the members are from the RBI while the other three members are appointed by the government.
  • Members from the RBI are the
  • Governor who is the chairman of the MPC,
  • Deputy Governor
  • one officer of the RBI.
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Reduction in Repo Rate: 

  • When Reserve Bank of India decides to cut the repo rate, the short-term loans for commercial banks become cheaper.
  • This prompts them to offer consumer loans at a relatively cheaper rate.
  • Many a times, base lending rate gets reduced with the reduction in repo rate.
  • Base lending rate is the rate below which banks cannot lend to its customers.
  • Reduced base rate increases the consumption as people will have more money at their disposal. 
  • This boosts the economic activities and prompts healthy growth with adequate supply of money in the market.

Source:”Economic Times “.

Possible UPSC CSE Mains Question:

Analyse the efficacy of the liquidity window opened by the RBI on uplifting the economy