RBI rate cut – Its impact and detailed analysis
Rate Cut and Rate Hikes are regular parameters tackled by RBI in its monetary policy. To understand what is a rate cut and when does RBI cuts rates, one need to understand the functioning and relationship between banks and RBI.
Reserve Bank of India (RBI) is an apex bank or central bank in India. It controls the functioning of all other the banks in India to ensure a healthy economic system. RBI regularly keeps lending money to banks for interest. At the same time, it also governs the amount of liquidity a bank should keep for its healthy operation. These are indicated in terms of % or ratios.
Periodically, RBI reviews these norms, rates, and ratios and takes corrective action in its monetary policy to stabilize the economy.
One of these actions is Changes in Repo Rates and Reverse Repo Rates and these changes primarily impact the liquidity in the economy and help to correct inflation of the country.
What is Repo Rate?
Repo rate is a rate at which the central bank of any country (i.e. RBI in India) lends money to commercial banks, in case of shortfall of funds. So, when banks are short of funds, they borrow funds from RBI at the repo rate. It is a benchmark rate for short-term lending by RBI and is also known as “Bank Rate”. In short, the repo rate is a rate at which liquidity is injected into the system.
What is the Reverse Repo Rate?
Reverse Repo Rate is a rate at which RBI borrows money from other banks for the short term. This is the rate at which the liquidity is absorbed from the banks.
What is “RBI rate Cut”?
When RBI declares its monetary policy, it makes necessary changes the Repo rate as well as Reverse repo rate. Generally, when the Repo rate is reduced by RBI, it is termed as “Rate Cut” and vice versa.
Why does RBI cut the interest rate?
There are several factors that affect the decision of the central bank to cut or hike the rate. But, predominantly RBI hikes or cuts the repo rate to control the inflation.
When the inflation in the economy is stabilized or low, RBI will cut the rate.
Inflation is an indication that people have more money with them to spend. It is also an indicator of a growing economy. Hence inflation and liquidity in the market are strongly co-related.
Low-level inflation can also lead to slower growth of the economy.
Hence, the rate cut or hike decisions also tackle the liquidity in the economy.
Why the Repo rate is reduced?
When the repo rate is reduced, banks find it cheaper to borrow money from RBI. As a result, banks too reduce their interest rate on loans given to their customers. This will encourage the customers to borrow money from banks and will increase the liquidity in the market.
As the banks will reduce their lending rate, at the same time, they may also reduce their deposit rates.
All this ultimately increases liquidity in the market. With more money available to end-users, economic growth tends to foster.
Why the Reverse Repo rate is reduced?
With the decrease in Reverse Repo Rate, the banks get less interest on deposits kept with RBI. This discourages banks to keep money with RBI and rather will lend it to customers.
As a result, the liquidity with banks is flown in the market with end consumers. The banks will have enough money available with them to lend to customers. This in turns increases overall liquidity with customers. As a result, the end customer’s spending power increases and will help the economy to grow.
Therefore, to increase liquidity and growth and doesn’t worry about the increase in inflation, RBI reduces the Repo rate. Whereas, when RBI wants the contraction of credit, it increases the Reverse Repo Rate.
What is the impact of Rate Cut on a common man?
If the RBI decides to cut the rate, the common man might get impacted in the following ways:
- Housing loans and other borrowings from banks will get cheaper.
- Interest rates on FD will be lower for new deposits.
- Easy liquidity in the market will lead to more purchasing power
- Inflation will increase and so will the overall economic growth.
Is there any impact of Rate Cut on the stock market?
Generally, the stock market factors-in the expected rate cut or rate hike ahead of the policy meeting. Any unexpected decision of RBI will affect the stock market. However, the rate cut or rate hike decision can change the general psychology of the company as well as the investors.
The impact of the rate cut mentioned above will help the stock prices to improve. With rate cuts and increased inflation and growth, the companies will get cheaper loans with increased consumer demand/revenue. This will increase the earnings of the company and in turn, their share prices will go up.