The Reserve Bank of India (RBI) has reduced the policy rates by 50 bps each with immediate effect. The Repo rate under LAF window has been reduced to 5.0% from 5.5% earlier.
This has been reduced aggressively from 9% in the mid-September 2008. The Reverse repo rate under LAF window has been reduced to 3.5% from 4% earlier.
Since mid-September 2008, RBI has reduced this by 250bps from 6%. Repo rate is the rate at which banks can borrow from the RBI through LAF windows whereas reverse repo rate is the rate at which banks park their surplus cash with the RBI for a short term.
Impact Analysis: Kotak Securities
The cut in policy rates by RBI is signaling lower interest rate regime to make banks lend more at lower interest rates (off course accompanied by reduction in their deposit rates).
Now question arises - Can we expect rates to come down dramatically? Our take is not exactly. The reduction in lending rate has to be accompanied by the reduction in deposit rates.
The deposit rates are less likely to come down unless yields on Gsec would also come down from here on.
However, higher government borrowing program is increasing the supply of government paper and thus pushing the yield higher (i.e. prices of bond going lower).
In the environment where other avenues like small saving schemes and PPF are offering higher rate, it would be difficult for the banks to reduce the deposit rates.
The banks have also become risk-averse and are going slow on lending to mid-size corporate on fear of defaults and increasing bad loans.
However, in our view, RBI by reducing the reverse repo rate to 3.5% has made it less attractive for banks to park money in LAF window. So, banks in away would be forced to lend to corporate.
Recently, RBI and IDBI had announced the cut in deposit rates. We believe that if 10-yr G-Sec would hover between 6 - 6.5%, the floor for one-year deposit rate would be around 8%.
So, unless yield comes down from hereon, the deposit rate would not come below 8%.
Click here to read analysis by Ambit Capital