Reforms taken by the Reserve Bank of India (RBI) to sustain the

position of India in the world economy

By Deepanjan Nag (1627112) and Debrup Paul (1627312)

Brexit i.e. “British exit”, was announced on February 19 after David Cameron
completed a negotiation with other EU leaders on the EU membership of the UK. As
a result of this announcement the British pound weakened 2.3% against the US
dollar, lowest in 7 years. The weakening of value of both Euro and Pound lead to
negative consequences on the world economy. Thai exports to the UK are about 2%
of total Thai exports, so the Thai economy was also affected. Due to the unlikely
event of Brexit, the EU and UK economies could put in recession. This could affect
Thailand’s export sector as combined exports from Thailand to the EU and the UK
account for 12% of total exports. India was also affected due to Brexit as the other
European economies reduced their demand for Indian exports. Now, this will cool
down if the long term phenomenon is considered; but in the short term it has affected
India. Also, Britain is itself a big importer of Indian Goods. So, the effect in the short
run is really unwanted. This is one example of an economic turmoil in our country.
The Reserve Bank of India is the controller of every financial aspect going on in our
country. Over the years, it has made various schemes by which it has controlled the
economic turmoils that hit our country. The various steps are Open Market
operations, Cash Reserve ratio, Statutory Liquidity Ratio, Bank Rate, Repo rate and
Reverse Repo rate.

Overview:

Open market operations (OMO) is the buying and selling

of government securities in the open market in order to control the
amount of money in the banking system, facilitated by the Federal
Reserve (Fed). Purchase of securities leads to the flow of money into
the banking system of the country and stimulates growth, while
selling the securities does the opposite and reduces the monetary
strength of the nation. The RBI nowadays frequently resorts to the
sale of government securities to which the commercial banks have been generously
contributing.

Cash Reserve Ratio (CRR) is a specified minimum fraction of the total deposits of
customers, that commercial banks keep as reserves either in the form of cash or as
deposits with the central bank. CRR is set according to the guidelines of the central
bank of a country. Presently the RBI has set CRR at 4%.
Statutory Liquidity Ratio (SLR) is the ratio of liquid assets to net demand and time
liabilities (NDTL), or, the share of net demand and time liabilities that banks must
maintain in safe to the liquid assets, for example, government securities, cash and
gold. The RBI has cut the SLR by 50 basis points to 21.25% on 3 February 2015.

The rate at which the central bank of a country (Reserve Bank of India in case of
India) lends money to the commercial banks of the country in the event of any
shortfall of funds is called Repo rate. By increasing the Repo rate, the central bank
is able to take away money from the commercial banks and hence these banks have
less money to lend to the people. This reduces the demand in the market and
thereby, controls inflation. Repo rate is used by monetary authorities to control
inflation. Currently, the repo rate set by the RBI is 6.25%.

On the other hand, the rate at which the commercial banks of a country lend money
to the central bank of the country is known as Reverse repo rate. It is a monetary
policy instrument which can be used to control the money supply in the country. The
present reverse repo rate set by RBI is 5.75%.

The next instrument is Bank Rate. It is the interest rate at which RBI lends long term
funds to various banks of the country. It is currently set to 6.75 %( Fourth Bi-monthly
Monetary Policy Statement, 2015–16). The bank rate is not used to control money
supply. If a bank fails to maintain SLR or CRR then RBI will impose penalty & it will
be 300 basis points above bank rate.

Selective Credit Control is another measure. Under this measure, instructions can
be given by RBI to other banks to not lend money to traders of certain commodities
e.g. sugar, edible oil etc. This is effective in preventing speculations/ hoarding of
commodities using the money that is borrowed from banks. This helps in controlling
inflation as this measure prevents money from going to the hands of the common
people and thus, they demand less due to less purchasing power.

Recent Measures of Reserve Bank Of India:

A slew of new reforms implemented by the present governor of Reserve Bank of

India, Sri Urjit Patel, has added a dash of colour to the festive season.

The cut in the repo rate by 25 basis points is one such measure which has not
only helped the commercial banks but it will also will be a bonanza for the common
man too.

Existing home and car loans will become much cheaper. The motive behind such a
step is that, lenders namely the banks, financial institutions will pass on or “transmit”
this rate cut to the customer.

Shanti Ekambaram, President-Consumer Banking, Kotak Mahindra Bank feels that

continuous monitoring of economic data will be needed and transmission of interest
rates would be accordingly addressed.
Shanti Ekambaram adds that the key observations will be around Brexit and the low
growth outlook globally, that has hindered the global trade sharply. These, coupled
with easy liquidity, are likely to keep global rates soft.

To explain how this rate cut would affect a consumer, we consider a loan amount of
Rs.50 lakhs which is to be repaid in 20years. A cut in the interest rate from 10% to
9.75% will lead to a reduction in payment period by 12 months i.e. the loan gets paid
off in 19 years, instead of 20 years. On the other hand, if one chooses to keep the
term constant, the EMI goes down to Rs. 47,425 from Rs. 48,251- which is a savings
of Rs. 826 per month.

The continuous fall in interest rate may result in an added reduction in interest rates
for the home loan consumers as confirmed by Rana Kapoor, MD & CEO, Yes Bank,
who had said that, considering a healthy set of domestic macros and a sustained
global deflation, he would expect a further easing of 75 bps in the coming months.

Banks have usually been slow in passing on the benefits of low interest rates to
borrowers, but this time, things may change if the interest rate continues its
downward journey.

Customers of home loans may want balance transfers during falling interest rates but
such transfers are beneficial only when the difference between the rates of the
existing home loan and the rate on offer is of at least 100 basis points. It is also
important to remember that it fetches the maximum benefits in the early years of
home loans. However, one must also factor in the charges and fees involved in the
balance transfer, which again can be negotiated, if one has a good credit score.

In the last couple of months, the fixed income investors have seen a reduction in
interest rates on corporate fixed deposits of around 20-25 basis points. The lowering
of rates by central bank in the economy, in turn reduces the interest rates payable on
fixed deposit. Sri Killol Pandya, Head - fixed income segment, Peerless Funds
Management, feels that, in near term, the policy is largely positive for domestic bond
market but one has to monitor the data prints regularly regarding inflation and then to
estimate how RBI nuances its policy accordingly.