In this blog I will explain some of the terms which are used with RBI Monetary policy like Repo Rate, CRR, Reverse Repo Rate, Basis Point, And how does Rate change affect individuals and Industry.
Reserve Bank of India (RBI) It is the central banking institution of India which controls the Monetary policy of the Indian rupee. It plays an important part in the development strategy of government of India.Terms explained in this blog are generic for all countries and instead of RBI, Central Bank of respective country need to considered while understanding it.
Relationship between RBI and Commercial Banks: RBI and Commercial banks has a very close relationship, but RBI always has the upper hand and dictate the terms based on the Economic trends.Having said that, RBI and Indian monetary policy has been appreciated many times in the past by the world and has so far not resulted in failure of any bank or banking system as seen in many other countries.Banks may get support from the RBI when they require and RBI can also ask for support based on the key rates which is under its control.
RBI Monetary Policy Review: RBI monitors the Macro-economic factors both in India and around the world and publishes a Monetary Policy review every month along with key revision of rates if there are any. Some of the key factors which RBI watch are Inflation, Growth in India and out of India,Liquidity of banks and key International events like Quantitative Easing and Monetary Policy review of US done by Fed(Current Fed chief Ben Bernake). Apart from these RBI also have the political pressure from the Ruling Party of India to influence moves and it has been brought up by RBI many times in the past.RBI release the Monetary policy on its website http://www.rbi.org.in/ and the December 2013 policy review can be read at http://rbi.org.in/scripts/BS_PressReleaseDisplay.aspx
Repo Rate: Based on the need , Commercial banks can get money from RBI at an interest rate.The Interest Rate charged by the RBI is called the Repo rate. e.g. if the Repo rate is 7.75%, Then Banks have to pay an interest of 7.75% on the money which RBI lend to them. An Increase in Repo rate will mean that banks will have to pay more interest on the money which it takes from RBI thus increasing its cost of funds. An increased cost of funds would mean that Banks will more likely increase the interest rate which it charge while giving loans to end consumers or Industry.
Basis Points: 1% is equivalent to 100 basis points.e.g. If Repo Rate is 7.75% and RBI increases it by 25 basis point, then new rate will be 8% as 25 basis point will be equal to 0.25%
Cash Reserve Ratio(CRR): Of all the funds which a commercial bank have, they have to deposit and keep a percentage of it with RBI. This percentage is called Cash Reserve Ratio. e.g. If the CRR is 4% then banks have to deposit and maintain regularly 4% of the their total deposit with RBI. So an increase in CRR rate will mean that banks will have to deposit to higher percentage of deposit to the RBI and in turn will reduce the liquidity the system has.This will mean that Banks will be able to lend lesser money to end consumers or Industry.
Reverse Repo Rate: This is the rate of interest at which RBI borrows money from the Banks,exactly opposite of Repo Rate. If RBI increase the Reverse Repo rate, then banks will be more interested in giving money to the RBI instead of giving it to other entities and this will result in reducing the liquidity available with the banks for giving it to end consumers or industry.
Impact of Repo Rate hike or CRR hike to consumers: Both these may result in increase in Interest Rate charged by the companies for the following
- Housing Loan: Housing Loan becomes costly because of this event although not every bank pass this to consumer every time. e.g. If the Current home loan you have is at 10%, then because of 25 basis point hike in Repo rate by RBI, Your bank will increase your Interest rate to 10.25%.
- Auto and Personal Loans: Banks might increase the Auto and Personal loan interest rate for fresh loans.
Rate cut will have opposite impact
Impact of Repo Rate hike or CRR hike on Industry and Growth(GDP): Industries take huge amount of loan from the banks and because of these changes, Banks increase the Interest rate at which they give loan to them and it puts pressure on the Industry balance sheet. Apart from this direct impact, It is impacted indirectly when lesser people buy Auto or Home because of higher interest rates.Any event which results in lesser liquidity in system will mean that banks will give lesser loans to Industry for new ventures and expansion thus impacting growth. Rate cut will have opposite impact
Impact of Repo Rate hike or CRR hike on Inflation: It is widely believed that Repo rate and CRR hike help in reducing the growth and the money available in the system and eventually decreases the demand. Decrease in demand will mean people will have lesser purchasing power and will result in lower inflation.Rate cut will have opposite impact.
Impact of Rate change on Stock Markets: Stocks are divided into 2 categories, Interest Rate Sensitive and Interest Rate Insensitive. Some Interest Rate Sensitive Sectors are Banks, Real Estate and Infrastructure which takes lot of capital from banks for project execution. Banks and Stock market players watch the Inflation numbers,Index of Industrial Production(IIP) numbers and GDP number closely and surveys are conducted especially across banking industry about consensus estimate of what RBI will do in next monetary policy.
If the actual changes during Policy review matches the estimates and if the RBI review tone is not extremely hawkish or dovish then market reaction is neutral. If it does not matches the consensus then we see a considerable move on either side.
Example: If the consensus estimate was that RBI will hike the rates by 25 or 50 basis points as the Inflation was quite high in the previous month,But RBI surprised by keeping the rates unchanged citing that Higher inflation was mostly because of onion prices and in the recent weeks Vegetable prices are seen falling sharply.Then it becomes positive for Nifty