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Current Affairs

Impact of RBI’s decision to cut repo rate

Date: 24 May 2020 Tags: Monetary Policy & RBI

Issue

The Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) slashed its key policy rates to stabilize the financial system and tackle the economic fallout from the ongoing nationwide lockdown to contain the spread of the coronavirus pandemic.

 

Background

The RBI panel unexpectedly cut the repo rate by 40 basis points to 4 per cent and the reverse repo rate by 40 basis points to 3.35 per cent. In another significant move, the RBI also announced extension of moratorium on loan repayments by another three months to August 31.

 

Details

  • The 40 bps cut in the repo rate will make funds cheaper for banks thus aiding them to bring down lending rates. This comes at a time when credit off-take is sluggish and investments have halted in the economy.

  • EMIs on home, auto, personal and term loan rates are expected to come down in the coming days. However, banks will also slash deposit rates on various tenures to manage its asset-liability position. Savers and pensioners will see their returns coming down.

  • The 40 bps cut in reverse repo rate, the interest rate that the RBI offers to banks for funds parked with the central bank, will prompt banks to make available funds for the productive sectors of the economy. Now, banks have been parking close to Rs 7-8 lakh crore at the RBI’s reverse repo window instead of lending these funds.

  • The RBI has now extended the moratorium on term loan repayment by another three months to August 31, 2020.

  • This will help borrowers, especially corporates which have halted production and are facing cash flow problems, to get more time to stabilize their operations and restart their units.

  • All borrowers, including home loan, term loans and credit card outstandings, will get the benefit of the moratorium.

  • Even though the lockdown may be lifted by end-May with some restrictions, economic activity even in Q2 may remain subdued due to social distancing measures and the temporary shortage of labour.

  • Recovery in economic activity is expected to begin in Q3 and gain momentum in Q4 as supply lines are gradually restored to normalcy and demand gradually revives.

  • Even as various measures initiated by the government and the Reserve Bank work to mitigate the adverse impact of the pandemic on the economy, it is necessary to ease financial conditions further.