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The Reserve Bank of India reduces its repo rate

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Rate cut

The Reserve Bank of India (or RBI), India’s central bank, surprised the financial world by unexpectedly reducing its key interest rate. The US Federal Reserve’s counterpart, the RBI is responsible for conducting monetary policy in India. Similar to the US federal funds rate, the repo rate is India’s key policy 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 a cue for commercial banks to reduce their rates. The rate in the below graph is derived from policy announcements and not specified periods.

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Reverse repo rate

The reverse repo rate, the rate at which the RBI accepts deposits from commercial banks, is 100 bps lower than the repo rate. The reverse repo rate decreased from 7.00% to 6.75%.

Meanwhile, the central bank kept the cash reserve ratio (or CRR) unchanged at 4.00% of net demand and time liabilities (or NDTL). CRR represents the percentage of total deposits of a bank that it must keep with the RBI in the form of cash and cash equivalents. CRR is another rate apart from the repo rate, which can be used to control the supply of money in the financial system.

Impact

Banks such as ICICI Bank (IBN) and HDFC Bank (HDB) can expect an increase in 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 if everything else remains the same. This can spell good news for India-focused ETFs like the WisdomTree India Earnings Fund (EPI), the PowerShares India Portfolio (PIN), and the iShares MSCI India ETF (INDA).

In the next part of this series, we will look at the RBI’s reasons for reducing the repo rate.

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