News: The Reserve Bank of India (RBI) has reduced the repo rate by 25 basis points (bps) to 6.25% on February 7, 2025. This is the first repo rate cut in nearly five years and follows a two-year period of maintaining the rate at 6.50%.
Rationale Behind the Repo Rate Cut
- Stimulating Economic Growth: The primary objective is to encourage borrowing, investment, and spending to drive economic growth.
- Inflation Within Target: With inflation under control, the RBI has room to lower rates without the risk of excessive price increases.
- Aligning with Global Trends: Many central banks worldwide have adopted accommodative monetary policies, making India’s move aligned with global trends.
- Reducing Lending Costs: Lower repo rates reduce banks’ cost of funds, allowing them to offer cheaper loans to businesses and individuals.
- Boosting Employment: Increased credit availability can help businesses expand, leading to job creation and higher employment levels.
Impact on Interest Rates and Borrowing Costs
- Reduction in Loan EMIs: Interest rates on home, vehicle, and personal loans will decline, lowering monthly EMIs for borrowers.
- Lower External Benchmark Lending Rates (EBLRs): Banks will reduce interest rates on loans linked to the repo rate, making credit more affordable.
- Marginal Cost of Fund-Based Lending Rate (MCLR) Impact: While banks have not fully passed on past rate hikes, the latest cut may result in cheaper loans.
- Higher Liquidity in the Market: With lower lending rates, borrowing will increase, boosting liquidity and consumption in the economy.
Impact on Investment and Consumption
- Cheaper Business Loans: Reduced borrowing costs will encourage businesses to invest in expansion, technology, and infrastructure.
- Boost in Consumer Spending: Lower interest rates make consumer credit more accessible, increasing purchases of homes, cars, and durable goods.
- Real Estate and Auto Sector Growth: With lower mortgage and auto loan rates, demand in these sectors is expected to rise.
- Stock Market Sentiment: Lower rates can improve investor sentiment, potentially leading to higher stock market activity.
Concerns and Potential Risks
- Possibility of Higher Inflation: Increased money supply and consumer spending could drive up prices, posing an inflation risk.
- Lower Savings Interest Rates: Deposit rates may decrease, making savings accounts and fixed deposits (FDs) less attractive for investors.
- Rupee Depreciation: A lower rate environment could lead to capital outflows, weakening the Indian rupee further.
