RBI cuts repo rate by 25 basis points to 7.75%: All you need to know

The RBI has resorted to the most kind cut by reducing the repo rate by 25 bps to 7.75%. Repo rate is the rate at which it lends funds to banks. The move is expected to bring down the borrowing costs in the economy, which the industry and the government believe is necessary to support the wobbly economic recovery.

Here are the key reasons why the RBI cut the policy rate:

1. Consumer price index-based inflation has been easing. The fall has been along the expected trajectory. It has also been consistent with the RBI’s assessment of balance of risks.

2. Inflation has declined because of the sharper-than-expected decline in prices of vegetables and fruits since September, ebbing price pressures of cereals and the large fall in international commodity prices, particularly crude oil. International crude oil prices have fallen more than 50 percent from June.

3. Weak demand conditions also moderated December inflation in items excluding food and fuel.

4. The government has reiterated its commitment to adhering to its fiscal deficit target of 4.1 percent for this year.

5. Households’ inflation expectations have adapted, and both near-term and longer-term inflation expectations have eased to single digits for the first time since September 2009. Households’ expectation about the movement of inflation is a key aspect that the RBI looks at for taking policy decisions. A softening in the expectations has boosted the RBI’s confidence in the containing inflation.

6. CPI, or retail, inflation is likely to be below the the RBI target of 6 percent in January 2016 because of all these, the central bank has said. “Inflation outcomes have fallen significantly below the 8 per cent targeted by January 2015. On current policy settings, inflation is likely to be below 6 per cent by January 2016,” the press release said.

7. Further rate cuts will happen only if data confirms continuing disinflationary pressures and the fiscal consolidation efforts by the government are of high quality.

8. The RBI will also watch out for the steps that the government will take to overcome supply constraints and ensure availability of key inputs such as power, land, minerals and infrastructure.

9. Such policy initiatives from the government are important to will ensure that output increases above the projected pick-up in growth in the coming quarters. If the output does not get ahead of the growth and demand pick-up, inflationary pressure will rear its head further, limiting the headroom for the RBI to further cut rates.