RBI keeps Repo rate unchanged

Last updated: 06 Aug, 2020 | 09:24 am

RBI keeps Repo rate unchanged
  • The  RBI's Monetary Policy Committee (MPC) has kept the repo rate unchanged at 4% in its bi-monthly policy meeting held today. The reverse repo rate too stands unchanged at 3.35%. 
  • Repo rate is the rate at which the RBI lends to commercial banks, and reverse repo is the rate at which it borrows from them. 
  • The MPC also decided to continue with the accommodative stance as long as it is necessary to revive growth and mitigate the impact of COVID-19 on the economy while ensuring that inflation remains within the target going forward. 
  • RBI said that these decisions are in consonance with the objective of achieving the medium-term target for consumer price index (CPI) inflation of 4% within a band of +/- 2%; while supporting growth.
  • 'This policy decision by the RBI to keep rates unchanged remains in line with our assessment (published last month)  that we are nearing the bottom of a rate cut cycle although policy will remain dovish (low rates) in the medium term.'

What’s happening in the current environment

  • Central Banks around the world are cutting interest rates to promote growth and liquidity. RBI has cut repo rate by 115 bps from 5.15% to  4% since January 2020. This is the lowest rate since 2000.
  • While the RBI has cut rates in the recent past increasing the availability of money in the economy, the effects of these cuts haven’t been felt to a large extent.
  • Despite the moves by RBI, banks have not been extending credit to the cash strapped economy. This is because of the heightened risk aversion by banks in lending, currently caused by a widespread disruption in the economy.
  • Data shows that investment into safe assets rose over 8.6% between the March and June quarters (for the 13 private banks that have declared earnings so far). That compares to a negative growth of 1.5% in their advances (Lending).
  • The data above clearly shows the extreme conservatism amongst banks. A sharp deterioration in the economy, however, has left lenders reluctant to lend to most segments.

What can be expected going forward?

  • We are at the bottom of the rate cut cycle. Even if the economic pick up is slow, we don’t see rates falling by over 50 bps over the next 6 months.
  • Clearly the RBI has a problem of transmission. Rate cuts are having a limited impact in giving business and the economy a boost, since banks are unwilling to assume the credit risk in this choppy environment.
  • The government has resorted to a much needed Fiscal stimulus by schemes that directly put money in the hands of certain targeted sectors- Although much more is expected.
  • RBI is also implementing operation twists and open market operations to reduce the long term yields and speed up the effectiveness of transmission of rate cuts.
  • The RBI remains constrained in it’s possible actions as rate cuts are having low impact on stimulating the economy while risk on impact to our currency remains high (lower interest rates lead to outflows from the country).!

INDmoney Recommendation

The credit risk, interest risk and liquidity risk are extremely serious in the system. It is very important to understand them before making any decision. Invest only high-quality AAA-rated bonds as they have the least risk. In fixed income securities, high risk does not mean higher returns.

There is a significant tax advantage in holding a debt fund for more than 3 years.For a more than 3-year investment horizon, an investor should prefer short duration (duration < 3) fixed income instruments over long duration. Short duration funds might not give you that extra alpha in the short term (3-6 months), but they are highly likely to outperform long duration funds in the long term. Shorter duration funds are also less sensitive to volatility in interest rates as compared to long-duration funds.

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