From THE HINDU group of publications
Sunday, June 03, 2001


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Implications of repo rate cut

B. Venkatesh

THE Reserve Bank of India has cut the repo rate by quarter per cent to 6.5 per cent.

What is the implication of this move? If the market expectations turn right, a cut in repo rate can well lead to a cut in the bank rate.

What is the link between the repo rate and the bank rate? The repo rate is the rate at which the RBI borrows from the banks, while the bank rate is the rate at which the banks borrow from the RBI. Naturally, then, if the RBI cuts the repo rate, it may not be long before it cuts the bank rate as well.

A cut in the bank rate could set off a series of rate reduction on fixed-income instruments. Banks, for instance, will lower the interest rate on their fixed-deposits. There could also be a small reduction in the loan rates they offer companies. This would prompt companies to lower interest rates offered on fresh retail bond offers. ICICI retail bonds, for instance, may fetch lower rates.

And that is not all. The repo rate has a direct bearing on the overnight or the call money market; this is the market where banks and primary dealers borrow money for one day to, typically, 14 days.

How does repo rate relate to the call rate? Repo rate typically acts as a floor rate for the call rate. If not, banks would make arbitrage profits. How? Suppose call rate is lower than repo rate, banks will borrow on call (if there are lenders) at a lower rate, and lend on repos to the RBI at a higher rate. As repo acts as a floor, a cut in repo rate will also lower call rates. And this would depress the returns from money market mutual funds that invest (lend) in the call market.

Of course, the positive side of a possible lower interest rate is that you can borrow money at a cheaper rate to buy an apartment and fill it with every conceivable consumer durable!

Related links:
RBI cuts repo rates by 25 bps to 6.5 pc

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