RBI’s Repo Rate Cut

The Reserve Bank of India’s (RBI) Monetary Policy Committee (MPC) has announced a 25 basis point (bps) cut in the repo rate, bringing it down to 6.25%. 

• GDP growth for 2024-25 is estimated at 6.4%, the slowest in four years.
• RBI estimates GDP growth for the next fiscal year (2025-26) at 6.7%.
• The government’s Economic Survey projected growth between 6.3-6.8% for 2025-26, supported by a strong external account, fiscal consolidation, and stable private consumption.

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Repo Rate Cut

• The reduction in Repo Rate is the first rate cut in five years (last cut was in May 2020).
• The repo rate was previously at 6.5%.
• The decision was unanimous by the six-member Monetary Policy Committee (MPC).
• The rate cut aims to stimulate economic activity by making borrowing cheaper, encouraging spending and investment.
• This comes shortly after the Centre’s personal income tax reduction, showing coordinated efforts to boost economic activity.

Possible Impact of the decision

• A reduction in the repo rate will lower external benchmark lending rates (EBLR), reducing EMIs for borrowers.
• Interest rates on loans linked to the marginal cost of fund-based lending rate (MCLR) may also decrease.

Monetary Policy Committee (MPC)

• The MPC is a six-member committee of the Reserve Bank of India responsible for setting the country’s monetary policy, primarily the repo rate. 
• MPC was established following a Memorandum of Understanding (MoU) between the Government of India and RBI to implement the inflation-targeting monetary policy framework.
• Legal Framework: The RBI Act, 1934, was amended by the Finance Act, 2016, to provide a statutory and institutional framework for the MPC.
• Inflation Targeting: The MPC aims to keep Consumer Price Index (CPI) inflation at 4%, with a tolerance band of 2% to 6%.
• Composition: It has 6 members including the Chairman.
  • 3 members from the RBI.
  • 3 government-nominated external members.
  • The Governor of the RBI serves as the ex-officio Chairman of the MPC.
• Meeting Frequency: The MPC is required to meet at least four times a year.
• Quorum: A minimum of four members is required for a valid meeting.
• Voting: Each member has one vote.
  • In case of a tie, the Governor has a second or casting vote.
• Monetary Policy Report: The RBI issues a Monetary Policy Report every six months, explaining the origins of inflation and providing inflation estimates for the next 6-8 months.

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Repo Rate

• Repo Rate (Repurchase Agreement Rate) is the interest rate at which commercial banks borrow funds from the RBI by pledging government securities as collateral.
• It is a tool to control inflation and liquidity in the economy.

Impact of Repo Rate Changes

• An increase in the repo rate raises borrowing costs, making loans expensive, reducing money supply, and helping control inflation. 
• Conversely, a decrease in the repo rate lowers borrowing costs, making loans cheaper, increasing money supply, and boosting investment and economic growth.
• Example: If the RBI lowers the repo rate from 6.5% to 6.25%, banks can borrow money at a lower interest rate, leading to cheaper loans for businesses and consumers.

Reverse Repo Rate 

• The reverse repo rate is the rate at which the RBI pays commercial banks for their surplus funds. It is always lower than the repo rate. 
• It is used to absorb excess liquidity from the banking system, helping in controlling inflation.

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Impact of Reverse Repo Rate Changes

• An increase in the reverse repo rate encourages banks to deposit more money with the RBI, reducing funds available for lending and helping control inflation. 
• Conversely, a decrease in the reverse repo rate discourages banks from depositing with the RBI, increasing funds available for lending and promoting investment and economic activity.
• Example: If the RBI increases the reverse repo rate, banks prefer to park their funds with the RBI instead of lending, reducing liquidity in the economy.

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