In the month of August, the Reserve Bank of India cut repo rate by 25 basis points to 6% in its latest credit and monetary policy review as was expected, reducing the key policy rates for the first time since October 2016, as falling inflation provided it room for monetary easing. The revised repo rate at 6% is the lowest in six-and-a-half years since November 2010.
This is the first policy rate cut since October 2016. Accordingly, the revised reverse repo rate and the marginal standing facility rate will now stand at 5.75% and 6.25%. RBI, in its last policy in June 2017, had narrowed the policy rate corridor by 50 basis points by raising the reverse repo rate and reducing the marginal standing facility rate.
Neutral stance of monetary policy
RBI kept its medium-term consumer inflation target at 4%, and said that the decision of the MPC is consistent with a neutral stance of monetary policy. RBI expects inflation to rise from current lows going ahead. Governor Urjit Patel said that farm loan waiver, GST, pay hikes are risks to inflation. He also said that excluding the impact of HRA, the headline CPI may be slightly above 4%. Core inflation has fallen significantly over past three months, he said.
In a significant move, the country’s largest lender and market leader SBI had reduced interest rate on savings bank deposits by 50 basis points, a development which will have implications of the interest rate regime.
Benefits of lower policy rates
Banks have fully passed on the benefits of lower policy rates set by the banking regulator to customers, contrary to the picture the Reserve Bank of India projected earlier when it expressed disappointment over banks not passing on the benefits.
All commercial banks have lowered their benchmark lending rates MCLR or marginal cost of lending rate during the period from an average of 9.50 per cent in April 2016 to 8.40 per cent in September 2017, it showed. While state-owned banks reduced one-year MCLR by 110 bps in the last 18 months, private banks have reduced rates by 85 bps from 9.80 per cent to 8.95 per cent and foreign bank lowered MCLR by 90 bps from 8.98 per cent to 8.08 per cent, the RBI data showed.
Transparency in pricing of loans
The sharp reduction in lending rates followed huge inflow of deposits to banks after the government banned Rs 1,000 and Rs 500 notes, and is partly due to the absence of demand for loans.
Recently, RBI proposed that banks should benchmark their lending rates to external rates to bring about transparency in pricing of loans. Speaking on the rationale for linking lending rate to external benchmark, RBI deputy governor Viral Acharya said: “We think that the internal benchmarks like the base rate or the MCLR, based on data, seem to give banks a very high amount of discretion lot of factors that are flexible for them to ensure that lending rates can be kept high even when monetary policy rates are going down an accommodative path.”