RBI Repo Rate cut Impacts:

Here's how 0.25% rate cut will affect you!

On the basis of its review of current developments in the economy, the Reserve Bank of India (RBI) has reduced the policy repo rate under the Liquidity Adjustment Facility (LAF) by 25 basis points from 6.75 per cent to 6.5 per cent; reduced the minimum daily maintenance of the cash reserve ratio (CRR) from 95 per cent of the requirement to 90 per cent with effect from the fortnight beginning April 16, 2016, while keeping the CRR unchanged at 4.0 per cent of net demand and time liabilities (NDTL); continued to provide liquidity as required but progressively lower the average ex ante liquidity deficit in the system from one per cent of NDTL to a position closer to neutrality; and narrowed the policy rate corridor by reducing the marginal standing facility (MSF) rate by 75 basis points and increasing the reverse repo rate by 25 basis points, with a view to ensuring finer alignment of the weighted average call rate (WACR) with the repo rate.

The RBI has taken advantage of a benign economic environment marked by subdued inflation, good growth prospects, and low fiscal and current account deficits. Its main concern is with the liquidity shortage in the economy. The average daily liquidity injection (including variable repos overnight and term repos) increased from ?1,345 billion in January to ?1,935 billion in March. Besides, durable liquidity was also provided through open market operations in February and March.

A  reduction in the key interest rate or repo rate will have the following effects:

Effect on consumers: Naturally, a fall in the interest rate prompts one to save less and spend more. Due to low interest rate, loans, particularly home loans will see a rise and this benefits the real estate market.

Start-ups can also avail loans at a lesser rate as banks and other lending institutions compete with each other to offer loans at the most favorable rates.

Price of commodities: It is not necessary that prices of commodities have to come down when interest rates go down. But if it does, it is beneficial to invest in say gold or appreciating assets such as real estate and book profits when they rebound, rather than spending on consumables.

Job market: When capital becomes cheaper, companies tend to expand their operations, thus, generating employment as they would need more manpower. This, coupled with government reforms will increase industrial output, and hence Gross Domestic Product.

Equity Markets: The positive impact on consumption along with lower interest outgo would also mean high profits and thus better valuations for the equity market. Further, lower interest rates means that money will move from lower yielding debt instruments to the risky, but high return yielding equity market.