In its latest monetary policy review, the RBI decided to cut the repo rate once again by an unexpected 35 basis points (0.35 per cent), rather than the customary 25 basis points. It was the central bank’s fourth rate cut in a row since former bureaucrat Shaktikanta Das became its governor. Repo rate refers to the rate at which the RBI lends money to commercial banks.

Why Does Monetary Policy Matter?

In any economy, economic activity happens by four ways. These are private individuals and households spending on consumption, the government spending on infrastructure, private sector businesses “investing” in their productive capacity and lastly, the net exports. At the heart of any spending decision made by these entities lies the question: What is the cost of money? The Reserve Bank’s monetary policy essentially answers that question. In every country, it is the central bank which is mandated to decide the cost of money, commonly known as the “interest rate” in the economy.

Will The Rate Cut Bring Investments?

Investments essentially depend on the “real” interest rate, that is, the difference between the repo rate and retail inflation. It is this interest rate that influences any investment decision. As a variable, the real interest rate allows an investor to compare the attractiveness of different economies. As the real interest rates in India have been going up, they have become one of the major reasons investments are not happening. The RBI’s recent move is expected to reduce the real interest rate and attract more investment. However, the key is to speed up the process of transmission of the rate cuts to the lending rates to end consumers so that they can invest in their dreams like buying Apartments in Goa!

It is worth pondering why commercial banks take so long to pass on the rate cuts to their retail customers. Ideally, banks should reduce their MCLRs automatically when the RBI cuts repo rates, leading to a reduction in interest rates on loans to customers. However, banks calculate their MCLRs on the basis of several factors including the cost of raising new funds, including the cost of maintaining the mandatory cash reserve ratio (proportion of total deposits that banks are bound to maintain with the RBI) and statutory liquidity ratio (proportion of total deposits that banks have to maintain themselves as liquid reserves), besides operating costs, etc.

The RBI’s rate cut of 35 basis points has given a much-needed shot in the arm to the liquidity and consumption volatility issues currently facing the Indian economy. This move will definitely help to ease the burden on current as well as prospective home buyers who want to buy properties in Goa or any other destination of their choice, provided banks respond promptly and lower their respective MCLRs. So ultimately, it all depends on how quickly the commercial banks will cut their own lending rates and pass on the benefit of the RBI’s cut to customers, be they individuals or corporates.