On Tuesday, Reserve Bank of India Governor Raghuram Rajan cut the repo rate, by 25 basis points at 6.50%.
Repo rate is the rate at which the RBI lends to banks. This also means that RBI has kept the window open for more rate cut.
The RBI kept the cash reserve ratio unchanged at 4 percent. Cash reserve Ratio (CRR) is the amount of funds that the banks are required to park with the RBI. If the central bank decides to increase the CRR, the available amount with the banks comes down. The RBI resorts to CRR tool to drain out excess money out of the system.
However, traditionally banks have not passed through the benefits of rate cuts to the retail customers. Banks use repo rate cuts to solve their structural problems. For example last year the RBI had cut the repo rate by 1.25 percentage points, however, banks reduced rates only by 0.70 percentage points.
Rajan it is evident is wary of a bad monsoon and impact of seventh pay commission, both could increase inflation. RBI expects that Seventh Pay Commission impact will be less compared to fifth pay commission.
But three variables has ensured that consumers will get the benefit of lower equated monthly installment on their loans. First, the marginal cost of funds-based lending rate (MCLR) ensures, if short term deposit rates fall, banks’ lending rates will be lowered in a more efficient manner, secondly, recent interest rate cut in small saving schemes and thirdly lower inflation which is now at 5.18%.
Hence, RBI in its bi-monthly monetary policy on Tuesday cut rates and hopefully banks will pass on substantial part of it to the customers.