Source: Mint
Context:
The Reserve Bank of India (RBI) reduced the repo rate by 25 basis points (bps) to 5.25%, citing a rare macroeconomic situation where growth is strong and inflation is exceptionally low. The move surprised sections of the market that expected the Monetary Policy Committee (MPC) to hold rates.
Why the Repo Rate Was Cut
1. Benign and Rapidly Falling Inflation
- Average CPI inflation for July–September fell to 1.7%, dipping below the 2% lower tolerance band for the first time since India adopted the inflation-targeting framework.
- October CPI was at 0.3%, signalling sharp disinflation.
- RBI revised FY26 inflation forecast downward to 2% (earlier 2.6%).
2. Robust GDP Growth
- GDP grew 8.2% in Q2 FY26 — the fastest in six quarters.
- RBI raised FY26 GDP forecast to 7.3% from 6.8%.
- Growth is resilient though some indicators like PMI and IIP show early moderation.
3. Policy Space + Low Inflation = Opportunity
Governor Sanjay Malhotra termed this a “rare goldilocks period” where inflation is low and growth is stable, enabling policy action to support momentum.
Impact of the Repo Rate Cut
1. Impact on Banks
- NIM Compression:
- 63% of floating loans are linked to repo/external benchmarks.
- Loan rates fall immediately, but deposit rates reprice slowly → NIM squeezes.
- Weak deposit growth means banks may need to raise deposits, not cut rates.
- Bond portfolios gain as yields fall.
2. Impact on Borrowers
- Cheaper EMIs on:
- Home loans
- Auto loans
- Personal loans
- Corporates benefit from lower working capital and long-term borrowing costs.
3. Impact on Economy
- Lower borrowing costs boost consumption and investment.
- Liquidity infusion supports credit flow, especially MSMEs and housing.
- Helps revive sectors showing early signs of slowdown (PMI, IIP softening).
4. Impact on Inflation
- Minimal near-term risk because inflation is already at multi-year lows.
- Some demand-led price pressure may emerge by mid-FY27.
What is Repo Rate?
Repo Rate is the rate at which the RBI lends short-term money to commercial banks against government securities.
Why Repo Rate Matters
- It is the key monetary policy rate.
- Determines borrowing costs for banks → influences loan rates (home, auto, personal loans).
- Used to control inflation:
- High repo = expensive loans = lower inflation
- Low repo = cheaper loans = support growth
What is Reverse Repo Rate?
Reverse Repo Rate is the rate at which commercial banks park their surplus funds with RBI.
Why It Matters
- Helps RBI absorb excess liquidity from the banking system.
- Used during high liquidity periods to stabilise money markets.
- A higher reverse repo encourages banks to deposit more with RBI rather than lend in the market.
