RBI’s decision to cut repo rate

RBI decides to cut Repo Rate by 25 basis point :

It has become a hot topic of RBI cutting repo rate, so in this article we will try to examine this issue from various possible dimensions. Before we proceed lets define repo rate; In laymen term it’s a rate at which RBI lends money to bank for short term borrowing. I used the term laymen because actually RBI signs repurchase agreement with the banks and both the statement are technically same with slight difference.

From definition itself it’s clear that a cut in repo rate could imply:
1) Economy is growing much below its speculated potential.
2) Low inflation

New governor of RBI, Shaktikant Das, has many time in his speech made it clear that there is no gap in actual and speculated growth of economy. In another words, Indian economy is growing at it’s potential.

Regarding inflation, RBI has been instructed to maintain inflation rate of between 2 to 6 % with 4% as mean. At present CPI inflation (Consumer Price Index) is 2.05 % that is at lower edge which provides enough hint to us for RBI’s move.

Question: Why RBI decrease only 25 basis point in repo rate? In India monetary policy doesn’t percolates easily to the bottom of monetary chain, which suggests RBI should have nudged a little bit more.

Answer:

Economic Aspect:
Although Inflation is low, but the core inflation of our economy is still extremely high. And it is the core inflation that affects the common people the most. So dovish approach by RBI on Repo rate could produce adverse effect on core inflation.

Political Aspect:

Government’s populist expenditure that also is such proximity to general election requires a huge amount of internal borrowing. RBI decreasing its repo rate will for sure benefit government to lower its financial stress.

Conclusion:

No matter weather this move of RBI was politically motivated or not, this move was bound to happen and should be welcomed without any politicization. If RBI was only to appease government it would have lowered repo rate by a larger basis point as RBI is at the lower limit of its target.

We hope that Public sector bank, because of its moral obligation will lower lending rate with immediate effect which will impact market competition leading to overall reduction in lending rate by banks. This may take around 2-3 month but will definitely boost the slouching economy.