More elbow room for banks to cut rates

As widely expected, the Reserve Bank of India (RBI) reduced the indicative policy rate (repo rate) by 25 basis points from 8 per cent to 7.75 per cent. This is likely to help banks reduce their lending rates.

Repo rate is the rate at which banks borrow funds from the central bank.

The central bank also cut the Cash Reserve Ratio (CRR), the portion of the deposits that the banks are required to maintain with the RBI, by 25 basis points from 4.25 per cent to 4 per cent, pumping in a liquidity of Rs.18,000 crore into the system from February 9.

The policy rate cut together with the CRR cut is expected to give more elbow room for banks to lend money at lower rates. This is likely to benefit retail borrowers immediately more than industrial sectors, where growth is subdued.

However, the rate cut does not mean that the RBI is comfortable with the macro-economic indicators which would allow it to cut rates.

“There is some space, but limited….. we use it with lot of judgement,” said D. Subbarao, Governor, RBI, on reducing the rates, while addressing a press conference to announce the third quarter review of the monetary policy.

This is the second policy rate cut in this financial year. The RBI front-loaded the cut with a reduction of 50 basis points from its peak of 8.50 per cent to 8 per cent in April 2012. Since then, ballooning inflation prevented the RBI from cutting rates. Meanwhile, slowing growth made RBI’s job much more difficult.

The RBI Governor said that this cut would “provide an appropriate interest rate environment to support growth as inflation risks moderate.” Dr. Subbarao also expected that investment would be encouraged, “thereby supporting growth”.

“With headline inflation likely to have peaked and non-food manufactured products inflation declining steadily over the last few months, there is an increasing likelihood that going into 2013-14, inflation will remain range-bound around the current levels,’’ the RBI said. The apex bank revised downwards the wholesale price inflation for the March-end 2013 from 7.5 per cent to 6.8 per cent.

“While the series of recent policy initiatives by the government has boosted market sentiment, it will take some time to reverse the investment slowdown and reinvigorate growth,” said Dr. Subbarao adding, “We have revised downwards our projection of GDP growth for the current year from 5.8 per cent to 5.5 per cent.”

"While the rate cut signals a monetary policy stance that is more supportive of growth, the CRR cut complements the same by seeking to address liquidity conditions and will facilitate transmission of the monetary policy stance into lending rates,” said Chanda Kochhar, Managing Director and CEO, ICICI Bank. She hoped that these measures would contribute to a recovery.

“The widening current account deficit (CAD) to historically high levels, especially in the context of a large fiscal deficit and slowing growth, exposes the economy to the twin deficit risk…..Large scale deficits will accentuate the CAD risk, further crowd out private investment and stunt growth impulses,’’ RBI warned.

“What economy needs most of all and most urgently is new investment. This will step up currently flagging aggregate demand and also ease the supply constraints so that existing capacity is fully utilised and new capacity is built up,” Dr. Subbarao added.