The Reserve Bank of India (RBI) on 15 January 2015 announced sixth Bi-Monthly Monetary Policy Statement. RBI in its bi-monthly monetary policy statement cut its main lending rate (Repo Rate) by 0.25 per cent with immediate effect. This is the first rate cut from the RBI since 2013.
With this, repo rate will now prevail at 7.75 percent from previous 8 percent. The RBI rate cut comes just two weeks before its scheduled policy review on 3 February 2015.
Based on the assessment of the current and evolving macroeconomic situation, the following changes has been taken
• Repo Rate: Reduced Repo rate under Liquidity Adjustment Facility (LAF) by 25 basis points from 8.0 percent to 7.75 percent with immediate effect
• Reverse Repo Rate under the LAF: Stands adjusted to 6.75 percent
• Cash Reserve Ratio (CRR): Kept unchanged at 4.0 percent of net demand and time liabilities (NDTL)
• Marginal standing facility (MSF) rate: 8.75 percent
• Bank Rate: 8.75 percent
Why the rate cut was necessitated?
• Inflationary pressures (measured by changes in the consumer price index) have been easing, since July 2014
• The path of inflation, while below the expected trajectory, has been consistent
• Inflation has been lower than expected due to sharp decline in prices of vegetables and fruits since September 2014 and receded pressures in respect of cereals and the large fall in international commodity prices, particularly crude oil
• It seems that the crude prices is expected to remain low over the year due to geo-political shocks
About Policy Rates
• Basis Points: It is the increase in interest rates in percentage terms. For instance, if the interest rate increases by 50 basis points (bsp), then it means that interest rate has been increase by 50%.
• Repo Rate: It is the rate at which commercial banks borrow from the RBI by selling their securities or financial assets to the RBI for a short-period of time. The repo rate is used by the central bank to increase liquidity in the system.
• Reverse Repo Rate: It is the rate of interest at which the central bank borrows funds from other banks for a short duration. The banks deposit their short term excess funds with the central bank and earn interest on it. This rate is used by the central bank to absorb liquidity from the economy. Generally it is one percentage less than the Repo rate.
• Bank Rate: The only way the bank rate is different from the repo rate is that the bank rate is the rate at which banks borrow money from the central bank without any sale of securities. It is generally for a longer period of time.
• Cash Reserve Ratio: CRR is the minimum percentage of cash deposits that banks must keep with the central bank. The current rate is 4%, which means for a cash deposit of 100 rupees, the bank has to park 4 rupee with the central bank.
• Marginal Standing Facility: The Reserve Bank of India in its monetary policy for 2011-12 introduced the marginal standing facility under which banks could borrow funds from RBI when there is a considerable shortfall of liquidity. This measure has been introduced by RBI to regulate short-term asset liability mismatches more effectively. Under this facility, banks can borrow up to 1% of their net demand.
• Liquidity Adjustment Facility: Under this facility, banks borrow from the central bank by pledging government securities. Repo rate and Reverse repo rate are part of it.
• Statutory Liquidity Ratio: This is the percentage of deposits that banks must mandatorily hold in the form of government bonds. SLR bonds are liquid assets that can be sold at a short notice to meet any unexpected demand from depositors.