RBI's Repo Rate Cut

The Reserve Bank of India (RBI) took a significant step in monetary policy by reducing the repo rate by 25 basis points (bps) to 6.25%, the first repo rate cut in nearly five years. This change is aimed at stimulating economic growth by making borrowing cheaper, which should encourage spending and investment.

What is the Repo Rate and Why Was it Reduced?

• Repo stands for “Re Purchase Option”.

• It is the rate at which the central bank (Reserve Bank of India) lends to other banks by buying the securities with an agreement that the bank will buy back on a certain date.
• Repo lending is a short-term lending option to meet the liquidity requirements of commercial banks.
• It is a part of the Liquidity Adjustment Facility (LAF) of the RBI.
• A 25 bps reduction in the repo rate means that borrowing for banks becomes cheaper.
  • Reason for the Cut: The rate cut is intended to boost economic activity. By making borrowing cheaper, the RBI hopes to encourage both individuals and businesses to increase spending and investment, thus promoting economic growth.
  • Inflation and Growth Outlook: With inflation within the RBI’s target range (around 4%), the RBI sees an opportunity to support growth without risking higher inflation. The GDP growth estimate for FY2025-26 has been pegged at 7%, and retail inflation is expected to be 4.2%.

How Will This Impact the Economy?

• Impact on Borrowing Costs: The repo rate cut is expected to lead to a reduction in interest rates for loans across the economy.
  • EMIs (Equated Monthly Installments) for home loans, vehicle loans, and personal loans are likely to fall, making borrowing cheaper for consumers.
  • Banks will reduce lending rates linked to external benchmarks (such as MCLR) and repo-linked loans. This will directly benefit borrowers by reducing their monthly repayment burden.
• Increased Accessibility to Credit: As borrowing costs decrease, businesses will find it easier to take loans for investment, and consumers will find it more affordable to borrow money for consumption.
  • This should lead to an increase in economic activity, as both consumers and businesses become more willing to spend and invest.
• Global Economic Context: The rate cut aligns India with global economic trends, where many central banks have adopted accommodative monetary policies to stimulate growth.

Potential Risks of the Repo Rate Cut

While the rate cut has several positive implications, there are risks:

• Higher Inflation: Lower interest rates could increase the money supply, leading to demand-driven inflation. While inflation is currently within target, the reduced cost of borrowing could push up demand for goods and services, potentially causing price rises.
• Lower Savings Returns: Interest rates on savings accounts and fixed deposits might fall, making it less attractive for individuals to save money.

Projections for GDP Growth and Inflation

• GDP Growth: The Indian economy is expected to grow at 4% in FY 2024-25, a slight slowdown from the previous year’s growth of 8.2%. The growth projection for FY 2025-26 is 6.7%.
• Inflation: Retail inflation is forecast to be 2% in FY 2025-26. The inflation outlook is positive due to falling vegetable prices and softening global prices for edible oils.
• Concerns on Inflation: Although inflation has moderated, concerns remain about its sustainability, especially with the Indian rupee touching 87 against the US dollar.