The Reserve Bank of India releasing its third quarter monetary policy has today announced a reduction in the repo rate and cash reserve ratio by 25 basis points. The new effective repo rate for the third quarter is now fixed at 7.25% while CRR rate has revised to 4%.
This move is likely to bring cheer to the stock market with the cut in CRR likely to inject Rs. 18,000 crore in the system increasing liquidity in the markets. The reduction in repo rates has effectually reduced the reverse repo rates down to 6.75% as well. The reduction, first in over nine months has been largely on expected lines as banking experts and finance ministry had expressed concern over contracting industrial output and falling growth. While the rate cuts may bring a smile to the finance ministry and stock markets, let us take a look at how it can impact the common man with respect to loans and term deposits.
Understanding Repo Rate and CRR: The rate at which the Reserve Bank of India lends money to commercial banks is known as repo rate while cash reserve ratio or CRR is the portion of bank deposits that all commercial banks have to deposit with RBI. With the announcement of the new rates in the third quarter monetary policy, Repo rate has been reduced by 25 basis points to 7.25% while CRR has also been reduced in the same proportion to reach 4%.
The Impact of Rate Cuts: Although inflation was a deterrent, the cut in repo rates is good news as it is likely to lower the cost of borrowing for both individuals and corporates. The reduction in CRR rate is likely to improve the availability of funds bringing in more liquidity to the system. With the announcement of RBI policy, banks would now consider lowering interest rates passing on the benefits to the end users.
While cutting of repo rate will be good for new borrowers if banks go ahead and cut their base rates, old borrowers under floating rates can expect a revision in interest rates.
The CRR cut is also likely to have a long term impact on the interest rates on deposits.While repo rate and CRR cut may bring down home and auto loans in the near future once the banks implements the RBI policy, fixed deposit rates are also likely to go down.
But prior to this move, ICICI Bank and Axis Bank had increased their deposit rate by 25 bps effective from 26th January and 24th January respectively. Although the banks have announced that the increase is only for longer tenures and with an intention to correct the gaps in their asset-liability growth, there remains a doubt on whether banks will reduce lending rates. So, in effect the tone of the new policy seems neutral. It is assumed that unless the deposit growth gathers momentum or credit growth has a moderate transmission, the net effect of rate cut will be neutral.