Following its pro-growth trend, Reserve Bank of India (RBI), on Thursday, has cut its repo rate for a third time lowering its lending rate by 25 basis points to 5.75% from 6.0% under the liquidity adjustment facility (LAF). This meant the reverse-repo rate under the LAF was automatically adjusted to 5.50 %, the marginal standing facility (MSF) rate and the Bank Rate to 6.0%.
Before analysing what were the factors driving this decision, here's what it means:
Repo rate is the rate at which the RBI lends money to commercial banks in the event of any shortfall of funds, this is done to tackle and control inflation. This decision would slash down interest rates which could be good news for the debt-ridden companies. For real estate the fall in interest rates could mean lower EMIs as banks would be receiving funds at a lower interest rate.
Reverse repo rate is the rate at which the RBI borrows money from the commercial banks within the country to control the cash flow in the market.
The above decision was taken to control consumer price index (CPI) inflation and keep it in the medium-term target zone of 4% within a band of +/- 2 % while pushing for growth in the economy, as written in the Second Bi-monthly Monetary Policy Statement released by the RBI.
Talking about the current market situation with respect to Repo rate, the RBI stated in its assessment that while the initial April-May period saw a deficit due to restrained government spending, June saw a boost in the liquidity. Detailing its operations in the monetary policy, RBI explained the swing in repo rates due to market conditions.
"Liquidity in the system turned into an average daily surplus of ₹66,000 crore (₹660 billion) in early June after remaining in deficit during April and most of May due to restrained government spending. The weighted average call money rate (WACR) – the operating target of monetary policy – remained broadly aligned with the policy repo rate: it traded above the policy repo rate (on an average) by 6 bps in April, but below the policy repo rate by 6 bps in May," read the statement.
Speaking about the previous reduction in repo rates done in February and April, RBI stated that the weighted average call money rate (WALR) reflected near full transmission of the reduction in the policy rate.
"Transmission of the cumulative reduction of 50 bps in the policy repo rate in February and April 2019 was 21 bps to the weighted average lending rate (WALR) on fresh rupee loans. However, the WALR on outstanding rupee loans increased by 4 bps as the past loans continue to be priced at high rates. Interest rates on longer tenor money market instruments remained broadly aligned with the overnight WACR, reflecting near full transmission of the reduction in the policy rate," read the statement