Repo Rate and Bank Credit

The Government of India has, on more than one occasion, mounted pressure on the Reserve Bank of India to reduce the rate of interest to encourage investment. The RBI has, however, remained cautious, but has reduced rates gradually since early 2015. At lower rates of interest, the fixed and administrative cost acquires more weight in the banks’ cost of funds which restrict their ability to reduce rates in proportion to the repo rate reduction and the gap between the two tends to widen. Lowering repo rates has not accelerated bank credit.

In the pursuit of pushing the growth rate of gross domestic product (GDP) upwards, the Government of India has been consistently mounting pressure on Reserve Bank of India (RBI) to reduce the rate of interest to boost investment. Industrialists, in general, were also in tune with this demand, whereas banks are struggling to reduce their increasing non-performing assets (NPAs). The average annual inflation in terms of consumer price index (CPI) has come down to 4.49% in 2016–17 (2.89% up to September 2017) from 4.88% in 2015–16, 5.88% in 2014–15, and 9.34% in 2013–14. In this situation, RBI has been treading a cautious path to manage inflation and growth rates through changes in its monetary policy instruments like repo rate, marginal standing facility rate, bank rate, statutory liquidity ratio, and cash reserve ratio from time to time.

Among these, the repo rate is the most important and has a direct bearing on the liquidity of banks and hence, their lending rates. The repo rate was the highest at 8% in January 2014 and it remained at this level till December 2014. After easing inflation since January 2015, the repo rate was reduced to 7.25% by June 2015 in three tranches of 0.25% each and further reduced to 6.75% on 29 September 2015 and then to 6.50% on 5 April 2016 and to 6% in August 2017. It is now at the lowest level since September 2010. In response to the reduction in repo rate, the State Bank of India (SBI) brought down its base rate from 10% in January 2015 to 9.10% in September 2016, and 8.95% in September 2017. Most other banks have followed the SBI rates. Thus, the repo rate has been intermittently reduced by 2 percentage points, that is, 25%, over the last two years and the base rates of banks also moved downwards, though not in tandem (Figure 1)..