Today's rate cut by the Reserve Bank took everyone by surprise. The Sensex turned celebratory before Holi, soaring to hit an all-time high of 30,000 points before paring gains later in the day.
This is the second rate cut since the one in January, which was a similarly unexpected move. RBI governor Raghuram Rajan's decision to cut the benchmark repo rate to 7.5 percent from 7.75 percent today indicates that he has reversed course and might go for more cuts in the following months, thanks to lower inflation. He was also encouraged by finance minister Arun Jaitley's intent to spend more on infrastructure than on subsidies, and formal adoption of inflation targeting by setting up a monetary policy committee. Repo rate is the rate at which the central bank lends money to commercial banks.
If you are a stock market investor, there is a good chance you already had a great day. But if you have taken a loan from banks for your car or house, this rate cut might bring lower rates and make your life easier. It is not necessary though — it is up to banks whether they want to pass on the cut in the repo rate. The last cut in January did not lead to any action from banks, partly because it was a minor one, and banks would have wanted to see further action.
"Regarding passing on the cuts by banks, it would depend on their cost of funds and it would be different for each one of them. However, with this second rate cut it does increase the possibility of passing on the decreased cost of funds to customers. As I mentioned, the quantum would depend on each bank," said Vaibhav Sanghavi, Managing Director, Ambit Investment Advisors Pvt Ltd, in an email to HuffPost.
"It's a very simple arithmetic that the rate cycle has reversed. If not today, tomorrow (bank interest) rate has to come down," said M.S. Raghavan, chairman, IDBI Bank. But it won't happen right away. "Probably by end of March all will decide as to what to do and then the rate cut will be passed on," he said in an interview.
Interest rates in India are still high compared with countries in western Europe where it is zero. In the United States, Federal Reserve chairman Janet Yellen has kept the key rate at 0-0.25% levels, enacted in 2008 during the worst global recession since the Great Depression of the 1930s.
Rajan will seek to bring inflation around the 4 percent target by April 2018. Future cuts will depend on how inflation pans out, and if the government is able to stick to its fiscal deficit and expenditure targets.