A relief of ‘25 basis points’

In the recent bi-monthly policy, announced on June 2, 2015, the Reserve Bank of India (RBI) has reduced its policy repo rate by 25 basis points, the third time this year. The trend of this reduction from 8% in the beginning of the year to 7.25% according to the second bi-monthly policy has taken advantage of the economic stability of the economy from a macroeconomic prospective and subdued inflation. The inflation has moved along the projected path and is hence under control. Therefore, as expected by the economists, the repo rate has fallen by a quarter percentage. But what does it imply?

Repo rate is the rate at which the central bank (RBI in case of India) lends money to the commercial banks in case of any shortfall or immediate need by the latter. Since commercial banks create money in the economy, any change in the money supply can only be brought through these banks. Hence, repo rate is also used as a quantitative measure to check inflation. In case of high inflation, the RBI would increase the repo rate to reduce the money supply. Similarly, it decreases the repo rate, increasing the money supply in an economy where the inflation is low or under control.

The decision of reducing the repo rate has started playing its role well in the economy. The trajectory is well defined here and so the impact of this reduction is clearly visible in the lending rates in the economy. With inflation under control, the economy is striving to improve its domestic capacity utilization and increase its capital stock. Economists are still hopeful to experience a further cut in the policy rates in the near future. The next bi-monthly policy is being awaited for!

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