InvestorQ : RBI has spoken about transmission of rates as a reason it did not cut repo rates? What exactly is that?
Arti Chavan made post

RBI has spoken about transmission of rates as a reason it did not cut repo rates? What exactly is that?

Answer
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2 months ago


Transmission is the extent to which the banks pass on rate cuts to the end borrowers. For example, if the RBI cuts repo rates by 100 basis points and the banks pass only 40 bps to the end borrowers, then the transmission is just 40%. Higher transmission is essential because otherwise the entire purpose of the RBI cutting rates is lost as the cost of borrowing does not go down.

In its latest Financial Stability Report or FSR that RBI had issued in the month of July for the first half of the year, RBI had noted that transmission had improved sharply. For instance, out of 115 bps that MPC had cut in April and June policies, nearly 88 bps has been passed on to the end borrowers. That is the highest transmission seen in the last five years and that is a positive signal. Then why did they not cut rates more?

Clearly, the RBI sees merit in waiting so that the full impact of transmission to play out on its own. RBI estimates that with the huge surplus liquidity in the system this 77% transmission can further improve to around 90%. That is when the full benefits of the rate cuts would be realized by borrowers and would make sense for the RBI to cut more.