At the 3rd bi-monthly monetary policy review for the Financial Year (FY) 2017-18, the RBI cut policy rates from 6.25% by 25 bps to 6.0%. This has been the lowest level witnessed in last 6 years. Similarly, it reduced the reverse repo rate to 5.75%. Repo is the rate at which banks borrow from the RBI, while the reverse repo is the rate at which they park their surplus liquidity with it. Reduction in policy rates is a precursor of fall in the interest rates in the economy.

Monetary Policy Committee (MPC) overwhelmingly voted in favour of a rate cut this time. Four out of its six members voted for a cut to the tune of 25 bps, while one member felt 50 bps rate cut would be appropriate. One basis point is a hundredth of a percent. Taking a slightly hawkish stance, another member voted in favour of maintaining the status quo.

RBI’s comments on its policy action

“On the state of the economy, the MPC is of the view that there is an urgent need to reinvigorate private investment, remove infrastructure bottlenecks and provide a major thrust to the Pradhan Mantri Awas Yojana for housing needs of all. This hinges on speedier clearance of projects by the States. On their part, the Government and the Reserve Bank are working in close coordination to resolve large stressed corporate borrowers and recapitalise public sector banks within the fiscal deficit target. These efforts should help restart credit flows to the productive sectors as demand revives. “

Assessment in detail

Major drop in inflation, delay in the recovery of private capex cycle, and slack in the manufacturing activities called for the RBI’s intervention. It has been working towards the objective of achieving the 4% inflation target with +/-2% margin of error. As against that, inflation in Q1, FY 2017-18 averaged 2.2%. Excess inventories in the energy sector and weaker activity in mining dragged the overall performance of the industry in Q1, FY 2017-18. As far as demand trends are concerned, rural demand remained vibrant which reflected in the satisfactory performance of the consumer non-durables sector. Nonetheless, the lacklustre pace in the urban demand recovery severely impacted the performance of the consumer durable sector.

Under such tough economic conditions, the RBI preferred to choose “supporting growth” as priority over containing inflation, which is low anyway. Despite the expected satisfactory performance of the agricultural sector on the promise of normal monsoon, the RBI estimates inflation in the H2, FY 2017-18 to pick up and stay in the range of 3.5% to 4.5%. As per the RBI’s assessment, farm loan waivers and the implementation of salary and allowance increases, a spike in the prices of vegetables and the animal protein products can prove to be inflationary. Nonetheless, the second-consecutive normal monsoon and moderation in the core inflation may act as a counterbalance.

How will this rate cut affect borrowers?

Ample liquidity present in the banking system and the lower credit off-take leaves room for further reduction in the lending rates of banks. Meaning, you can expect home loans, auto loans, and business loans to become more affordable. So you can expect bankers to offer you attractive festival deals this year.

Impact on investors

Bond markets and equity markets were factoring in a 25-bps rate cut even before the policy statement was released. Hence, this came as a no surprise to the majority of institutional investors. You shouldn’t speculate on any macro-economic development including the RBI’s monetary policy actions.

On the contrary, you should invest as per your personalised asset allocation that factors in your financial goals and risk appetite. For any assistance on financial planning, you might search for a Certified Financial Guardian in your vicinity.

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