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RBI stimulus: Spread between policy rates at 4-year high

The spread between the repo and reverse repo rates has increased for the second time in a row to touch a four-year high of 65 bps from 40 bps earlier

twitter-logoNiti Kiran | April 17, 2020 | Updated 19:55 IST
RBI stimulus: Spread between policy rates at 4-year high
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In fight against the coronavirus-induced slowdown, the Reserve Bank of India has come up with another round of measures to boost liquidity, incentivise bank credit flows, ease financial stress and enable normal functioning of markets.

The central bank reduced the reverse repo rate, the rate at which banks park their excess liquidity with the central bank, by 25 basis points (bps) to 3.75 per cent. It, however, kept other key rates, including repo rate, unchanged. With this, the spread between the two policy rates, the repo and reverse repo has increased for the second time in a row to touch a four-year high of 65 bps from 40 bps earlier. This will discourage banks from parking their excess liquidity with the central bank.

"The reverse repo rate cut is to discourage reverse flow to RBI. But it is doubtful whether this flow can be stemmed easily. Banks are not lending or investing because they fear that under the current conditions they may be adversely impacted if they employ the money for investments or lending. Even three months back the approach of the banks was one of extreme caution. RBI has now specified where the money should go to encourage sectoral lending. Once a clear channelisation of credit to segments or sectors that require the support is achieved, the economy will get the much-needed stimulus," said Joseph Thomas, Head of Research - Emkay Wealth Management.

In its first stimulus that was unveiled on March 27, the central bank announced a massive 75 bps cut in repo rate coupled with 100 bps reduction in cash reserve ratio. The reverse repo rate too was slashed by 90 bps raising the corridor between the key policy rates for the first time in a decade to 40 bps. The spread between the repo and reverse repo has narrowed by 1.25 percentage points from 1.5 percentage points in July 2010 to 0.25 percentage points in 2019. Though, in the last two years (between 2017 and 2019), the spread remained constant at 25 bps.

The RBI uses the reverse repo to manage cash-flow in the economy and has consistently reduced this rate from 6 per cent in early 2019 to 3.75 currently.  "On April 15, the amount absorbed under reverse repo operations was Rs 6.9 lakh crore. In order to encourage banks to deploy these surplus funds in investments and loans in productive sectors of the economy, it has been decided to reduce the fixed rate reverse repo rate," the governor said in the statement.    

Inflation trajectory is on a decline, having fallen by 170 basis points from its January 2020 peak. In the absence of supply shock, inflation could fall below the RBI's target of 4 per cent by second half of 2020/21. "Such an outlook would make policy space available to address the intensification of risks to growth and financial stability brought on by COVID-19. This space needs to be used effectively and in time," RBI added.

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