Will RBI Rate Cuts Arrest Economic Disruption???

The government issues the currency notes known as the "Legal Tender" and accepted by all. RBI is the Central bank of India that prints currency notes and it bears the Governor's signature on it.

It is the responsibility of RBI to

1. control the supply of money and decide as to how much money is to be made available for the industry or the economy  and

2. "cost of credit", ie, the price that the economy has to pay to borrow that money.

Supply of money and cost of credit are closely monitored and controlled by RBI being a Central bank.

The inflation and growth in the economy are primarily impacted by these two factors -- supply of money and cost of credit.

A bank under cash reserve ratio (CRR) a certain percentage of the total bank deposits needs to be kept in the current account with RBI which means banks do not have access to that much amount for any economic activity or commercial activity. Banks don’t earn anything on that. CRR has been slashed by 100 bps (basis points) to 3%. The primary purpose of CRR is for ensuring some liquid money against deposits while its secondary purpose is to allow the RBI to control liquidity and rates in the economy.

Banks earn some amount of interest on Statutory Liquidity Ratio (SLR). SLR has an upper limit of 40% and a lower limit of 23%. SLR is a liquid asset, the percentage of the total bank deposits available as far as the particular bank is concerned. The SLR money goes into investment predominantly in the central and state government securities.

Banks approach RBI when they need money. The rate at which banks borrow money from the RBI by selling their surplus government securities to RBI is known as "Repo Rate." Generally, these loans are for short durations up to 2 weeks.

Thus  RBI lends money against the pledge of government securities whenever the banks are in need of funds to meet their day-to-day obligations to commercial banks at Repo Rate. 

RBI also borrows money known a Reverse Repo Rate.

So, higher the repo rate higher the cost of short-term money and vice versa.

Higher repo rate may slowdown the growth of the economy.

If the repo rate is low then banks can charge lower interest rates on the loans taken by us.

So whenever the repo rate is lowered by RBI, we expect both the deposit rates and lending rates of banks to come down to some extent?

Yesterday the 27th March, the RBI has slashed Repo rate to 4.4% from 5.1%, down by 75 basis points (bps) to help arrest the projected economic slowdown.

The basis point is calculated as 1% equivalent to 100 basis points (bps).

The Repo Rate was 5.1% and RBI decreased it by 75 basis points to effect the new rate to come down to  4.4% (as 75 basis points will be equal to 0.7%).

All banking institutions, housing finance companies and other Non-Banking Financial Company (NBFC) have been allowed by RBI a three-month moratorium on payment of instalments on term loans in view of the disruption caused by the coronavirus outbreak. RBI clarified that it would extend to all retail loans, thus providing relief for individuals who have taken out home or auto loans and credit card dues from March 1, 2020 to May 31, 2020.

In other words the repayment schedule and all due dates, as may now be shifted across by three months.

Deferment of loan repayment will not impact the credit history of the borrower, the RBI assured.

Three-month moratorium on payment of term loan EMIs and interest on working capital loans would give, in the words of Nirmala Sitaraman, "much-desired relief”.

The fact of the matter is that RBI's move has come after many renowned rating agencies have slashed India’s growth projections. Moody's projections are very disheartening. India's GDP growth has been slashed to 2.5% from her earlier estimate of 5.3% as Moody's analysis points sharply towards the ill effects of coronavirus pandemic and national lockdown may further add unprecedented shock to indian economy which is most likely to witness a sharp fall in incomes weighing on domestic demand and the pace of recovery.