The Reserve Bank of India (RBI) has consecutively slashed repo rates five times since January 2019. Repo rate is an interest rate at which commercial banks borrow money from the RBI in the case of funds shortage. It acts as a significant tool for RBI to keep inflation under control.
Repo rate is considered to be a powerful weapon under the Indian Monetary Policy that can regulate the money supply, liquidity, and inflation levels of the country. It has a direct relationship with the interest rates offered to individuals and businesses by the commercial banks.
That is if RBI increases the repo rate, it makes borrowing a costly affair. In turn, investments slow down, and the same applies to the money supply in the economy; it brings down inflation. On the other hand, if the repo rate is lowered, businesses and individuals find it cheaper to borrow money for various investments. This lets money flow in the economy and boosts it.
Expectation: Rate Cuts Can Cheer Borrowers
The latest repo rate cut announced on 4 October 2019 brought it down by 25 basis points (bps). This has brought down the repo rate to 5.15%, which is the lowest since March 2010. The rate cut is in line with the expectations of the industry experts and citizens. Accordingly, RBI has pulled down the expected GDP growth rate from 6.9% to 6.1% for FY20.
Rate cuts have pushed the banks to reduce the marginal cost of funds based on the lending rate (MCLR). This reduction leads to a reduced EMI for the borrowers as EMIs are calculated based on the bank’s MCLR, together with the margin of the bank.
The government expected that the drop in the effective interest rate on loans would spike the demand for loans among individuals as well as businesses. It speculated that the rise in demand would set more money flowing into the system, as it increases investments and sales. However, the expectations do not seem to have been met.
Reality Check: Rate Cuts Have Not Attracted Borrowers
Irrespective of the efforts put by RBI to improve the economy and money flow, the equity and debt markets have failed to yield positive results. The overall picture hints the necessity of further rate cuts in future policy meets if the GDP growth estimates fall further.
It is heard that the debt market participants expected bigger rate cuts because of the global slowdown. Since the rate cuts have not been satisfactory, borrowers are being sceptical about initiating the action. They are instead waiting for the next rate slash announcement from RBI keeping in mind the extent of the global slowdown. This is backed up by the fall of Purchase Manager Index in developed markets below 50.
Another reason for borrowers to not apply for loans as expected is that the talks of a probable recession period are all over the place. Individuals may not want to get themselves into a new obligation when their future is uncertain. This sentiment results in a dropped enthusiasm in the loans sector.
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