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Monetary Policy Review: RBI Cuts Key Rate to 5-Year Low
Apr 07, 2016

On 5 April the Reserve Bank of India cut key interest rate by 0.25% and introduced a host of measures to smoothen liquidity supply so that banks can lend to productive sectors and indicated accommodative stance going ahead.

Home loans and other borrowings are set to get cheaper by at least half a percentage point in the coming months as RBI Governor Raghuram Rajan cut rates by 25 basis points to 6.50%—an over-five-year low.

Key Points

  • The Repo rate, at which RBI lends to the financial system, has come down to 6.5%.

  • In the first bi-monthly monetary policy review for the 2016-17 fiscal, which began on April 1, a reduction in the policy rate by 0.25% will help strengthen growth.

  • RBI Governor Raghuram Rajan also took a host of measures on the liquidity front, starting with the narrowing of the policy rate corridor to 0.50% from the earlier 1 percentage point, which resulted in the Reverse Repo Rate (at which banks can park excess funds with the RBI) being reset at 6%.

  • The policy said the average overnight borrowings by banks have increased to Rs 1,935 billion in march from Rs 1,345 billion in January.

  • Stating that inflation objectives are closer to being realised and price-rise will hover around the 5% mark for remainder of fiscal, RBI reaffirmed that monetary policy will continue to remain accommodative to address growth concerns.

  • RBI also retained its GDP growth forecast at 7.6%, on the assumption of a normal monsoon and a boost to consumption through the implementation of the Seventh Pay panel recommendations.

  • The central bank expects the implementation of Seventh pay panel suggestions will hurt inflation by 1-1.5% over a two year period, but the shock will not be as strong as that felt during the implementation of the Sixth pay panel suggestions.

  • RBI welcomed the government move to amend the RBI Act to create a monetary policy committee, saying it will further strengthen the policy’s credibility.

RBI said that borrowing rates are coming down significantly. On April 1 most banks reduced their lending rates in the course of switching to a new benchmark—the Marginal Cost of Lending Rate (MCLR). Unlike the earlier benchmark—the base rate which was reviewed quarterly—the MCLR, which is a rate derived out of incremental cost of deposits, is reviewed every month.

RBI said that it would infuse liquidity to ensure that shortage of short-term money—which is around one per cent of bank deposits of Rs 93 lakh crore—would vanish. At present, because of the liquidity deficit, banks borrow around Rs 80,000 crore every day. This increases their cost of funds and prevents them from reducing deposit rates.

RBI narrowed the policy rate corridor to 0.50% from the earlier one percentage point, which resulted in the reverse repo rate—the rate at which banks park surplus funds with RBI—at 6%
RBI also reduced the daily requirement for maintaining Cash Reserve Ratio to 90% of the statutory requirement from 95% earlier. CRR is the portion of bank deposits that has to be mandatorily parked with RBI.


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