The Reserve Bank of India (or RBI), India’s central bank, surprised the financial world by unexpectedly reducing its key interest rate.The RBI reduced the repo rate by 25 basis points (or bps)to 7.75% on January 15, 2015. One basis point is 1/100 of 1%, so 1% equals 100 bps. The repo rate is the rate at which the RBI lends money to Indian commercial banks. Changes in the rate also signal an increase or decrease in rates to commercial banks. A reduced rate by the central bank is cue for commercial banks to reduce their rates. It will lead to more money in the hands of the consumer and greater spending. It is a positive for the Indian economy.
1. Path of inflation:Since September 2014, prices of vegetables and fruits experienced a sharper-than-expected decline.The price of cereals experienced ebbing price pressures.International commodity prices, particularly crude oil, experienced a significant decrease.
2.Fiscal deficit target: Government's assurance of sticking to its fiscal deficit target of 4.1% in the current fiscal year.Reports from Finance Ministry reveals that all efforts were being made to ensure that the government does not default on the fiscal deficit target.
3.Inflation expectations: Households inflation expectations is in comfortable zone both near-term and longer-term and eased to single digits for the first time since September 2009. Inflation is below the targeted 8 per cent by January 2015. On current policy settings, inflation is likely to be below 6 per cent by January 2016,
Indian markets react to a reduction in India’s repo rate
Why the Reserve Bank of India cut the repo rate
The RBI monitors inflation closely, and it also keeps crude oil prices and food prices on its radar.A fall in both of these led the consumer price index (or CPI) inflation down in recent months.The CPI inflation for December 2014, which was released on January 12, 2015, showed a rise of 5.0% from a year ago. Although it rose from a 4.4% pace set in November 2014, it was below the RBI’s target of 8.0% by January 2015.Three reasons for inflation being lower than expected:
Aims to boost growth amid slowing inflation. Policymakers also signaled further monetary easing, depending on continuing disinflationary pressures, fiscal consolidation and supply constraints. Both Union Bank of India and Kolkata-based United Bank of India both cut their base rate, or the rate below which they cannot lend to borrowers, by 25 bps to 10%. Banks such as ICICI Bank (IBN) and HDFC Bank (HDB) can expect an increase in quantity of loans if they reduce their rates as well.the rate cut should also help corporates borrow cheaply, which should help lower their borrowing costs and increase their profits
In response to the move Indian stock markets welcomed the Reserve Bank of India’s (or RBI) move of reducing the repo rate by 25 basis points to 7.75%. Benchmark equity indices like the S&P BSE Sensex and the CNX Nifty ended the day up over 2.6% each. The S&P BSE Sensex had risen by 3.1% over its previous close before reducing some losses and ending at 28,075.5.This move may cause a reduction in interest rates on home loans and lower EMIs as well as more funds available to the builders.
It provide growth momentum to the market by injecting liquidity to the market.
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