RBI's repo rate cut won't bring your EMIs down

The central bank can't do much when it comes to lowering interest rates or in turn your EMIs

The Reserve Bank of India’s (RBI) 25 basis point repo rate cut is unlikely to considerably change your financial landscape. Theoretically, this might mean lower interest rates charged by banks on loans. However, practically it might not happen at present.

 

Deciphering the tone of the RBI statement, financial analysts predict that interest rates are not going to fall sharply in the coming months.

 

Lower interest rates make it easier for people to borrow in order to buy cars and homes. Purchases of houses, in turn, raise the demand for other things such as furniture, appliances and so on, thus providing an additional stimulus to the economy. Drop in interest rates mean that consumers spend less on interest costs, leaving them with more of their income to spend on goods and services.

Business Standard explores RBI can’t do much when it comes to lowering interest rates or in turn your EMIs 

What is repo rate and reverse repo rate?

 

The repo rate is that at which the central bank provides liquidity to banks. In other words, it means the rate at which the RBI lends money to commercial banks against the pledge of government securities whenever the banks are in need of funds to meet their day-to-day obligations.

 

In the credit policy announced on Friday, RBI reduced this repo rate by 25 basis points, i.e. by 0.25% (100 basis points equals to 1%) to 7.25%. This means that the banks are now able to borrow funds from RBI a little cheaper by 0.25%.

 

The reverse repo is the rate at which the apex bank mops up funds from banks. The funds are for the short term in both the instances.

Impact of repo rate cut 

The repo rate cut, for the third time since January, is seen as an attempt by the RBI to boost growth. Experts say the driving factor for a repo cut is basically to pull down the cost of funds.

The slowdown in the economy especially in infrastructure sector is coming from a drop in investments, and that has to be reversed.

The RBI once again urged the government to take measures to ease supply constraints in the economy and encourage investment.

 

The economy expanded at the weakest pace in a decade last fiscal year, and wholesale-price inflation slowed in March to a more than three-year low even as consumer inflation held above 10%.

 

So whenever the repo rate is slashed, a ray of hope appears that both the deposit rates and lending rates of banks would come down to some extent. 

 

Nevertheless, the lending rate of banks goes down to the existing bank borrowers only when the banks reduce their base rates, as all lending rates of banks are linked to the base rate of every bank.

What is base rate?

It is the minimum rate of interest that a bank is allowed to charge from its customers. Unless mandated by the government, the apex bank rule stipulates that no bank can offer loans at a rate lower than base rate (BR) to any of its customers. A bank can change its BR every quarter, and also during the quarter.

 

The repo rate has little impact on the base rate. The only thing that impacts the base rate is cash reserve ratio (CRR). A cut in the CRR will make a vast amount of cash available to banks and thereby reduce their need for deposits, thus paving the way for a lending rate cut.

What is CRR?

CRR is that portion of deposits which must be maintained with the RBI. The central bank kept the CRR for banks unchanged at 4%. The RBI often uses CRR as a tool to control liquidity in the system.

 

According to data released by the RBI on April 12, for the year ended March, deposits stood at Rs 10.27 lakh crore, recording a rise of 17.4% year-on-year.

 

Total bank credit in 2012-13 stood at Rs 7.8 lakh crore, a rise of 17%. Of the total credit, Rs 2.7 lakh crore was disbursed in March. This is the first time since 2009-10 that annual deposit growth outpaced credit growth. 

 

When the deposit rates have been increased, there is no case for reducing the lending rates, as any cut in lending rates without corresponding drop in deposit rates would eat into their margins and hurt banks’ profitability.

Risks ahead?

The central bank has warned that the risk of inflationary pressure persists despite a recent sharp decline in WPI inflation, and said a high current account deficit (CAD) poses the biggest risk "by far" to the Indian economy. "The balance of risks stemming from the Reserve Bank's assessment of the growth-inflation dynamic yields little space for further monetary easing," the RBI wrote in its policy statement.

 

The high inflation is burning a hole in common man’s pocket. It also makes way for diversion of bank deposits into real estate and gold as a hedge against inflation. To bring economy to a high growth trajectory is to revive investment. A competitive interest rate is sine qua non for this, but not enough. 

 

As the government borrows more to bridge the budget deficit it leads to interest rates going up adding to inflationary pressures in the economy.