Here is a good explanation in the "Live Mint about why Government of India would love a repo rate cut, which is the rate at which the RBI lends to Banks. The article extracts from Viral Acharya’s latest book “Quest for Restoring Financial Stability in India”.
The Reserve Bank of India (RBI) on Thursday decided to keep the repo rate or the interest rate at which it lends to banks, at 4%. In his new book, former RBI deputy governor Viral Acharya explains why the government loves the cycle of repo rate cuts.
What does Acharya say in his book?
Viral Acharya writes in Quest for Restoring Financial Stability in India: “Rate cuts are preferred … whereas rate hikes are particularly disliked." Now, this is primarily because the government is a major owner of the public sector banks (PSBs).
What is the problem with repo rate cuts?
The government is trying “to keep the budgetary allocation for public sector banks’ capital needs low". Repo rate cuts help in doing that. When the repo rate is cut, the value of the government bonds held by the state-owned banks goes up. This is because when interest rates go down, bond prices go up and vice versa. When bond prices go up, the PSBs end up making profits. This profit is recognized almost immediately, and helps shore up the capital base of these state-led lenders. Also, the government does not have to dip into its budgetary revenues to shore up the capital of public sector lenders.
This might at best be a temporary fix and cannot substitute the need for prudential lending practices and for better recovery by Banks.
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