Mumbai: The Reserve Bank of India (RBI) on Tuesday slashed its key lending rate and banks’ cash reserve ratio (CRR) by a quarter percentage point each, setting the stage for a recovery in growth.
In its third quarter review of the monetary policy, the central bank maintained that inflation had peaked. Together with the cut in policy rates, it will, according to RBI, create the appropriate macroeconomic environment to revive investments in the economy and thereby begin reversing the free fall in growth witnessed so far.
IDBI Bank Ltd was the first to take the central bank’s cue by slashing loan and deposit rates. National Housing Bank (NHB) and Royal Bank of Scotland NV (RBS) too cut their prime lending rate; other banks are expected to follow suit.
This is the first time in nine months that RBI has lowered the repo rate, drawing comfort from wholesale inflation easing in recent months, which was hovering way above the central bank’s comfort zone till October.
The cut in the repo rate, at which RBI lends short-term funds to banks, and CRR, the portion of deposits banks need to park with RBI, will immediately translate to cheaper lending rates for borrowers as banks are gearing up for rate cuts. IDBI Bank cut its base rate, or minimum lending rate, by 0.25 percentage point to 10.25%, effective 1 February. Deposit rates have been cut by an identical margin for certain maturities.
NHB also cut its prime lending rate by 25 basis points (bps) to 9.75% with immediate effect.
RBI cut the repo rate to 7.75% and CRR to 4%. The cut in CRR, effective the fortnight beginning 9 February, will infuse Rs.18,000 crore of liquidity into the banking system.
The asset-liability committee of State Bank of India (SBI), the nation’s largest lender, will meet on Wednesday to review its loan rates. Other leading banks, including Punjab National Bank, ICICI Bank Ltd, HDFC Bank Ltd and Union Bank of India, too, have hinted at rate cuts.
Most lenders are likely to cut their base rate, or minimum lending rate, this time unlike in the past when rate cuts were limited to certain segments.
A cut in the base rate will benefit all categories of borrowers. SBI, which cut its base rate by 25 bps to 9.75% in September, has the lowest base rate. A basis point is one-hundredth of a percentage point. “It would be helpful in improving investment climate and start the capex cycle. SBI would do full monetary policy transmission and reduce cost of capital,” SBI chairman Pratip Chaudhuri said.
K.R. Kamath, chairman and managing director of Punjab National Bank and head of the Indian Banks’ Association lobby group, said there is a case for a rate cut by banks. “A CRR cut along with the policy cut will help the banks improve earnings,” he said.
“In the current situation, deposits are growing lower than credit. We are watching the situation on deposits,” said Chanda Kochhar, managing director and chief executive of ICICI Bank.
The last time RBI cut the repo rate was in April 2012, by a higher-than-expected 50 bps. In the past one year, RBI has cut CRR four times to infuse liquidity into the system.
The central bank’s decision to cut interest rates will stimulate investment and help in anchoring inflationary expectations, Prime Minister’s economic advisory council chairman C. Rangarajan said.
“RBI has taken a very balanced view. This will ensure that stimulus is provided to growth while continuing efforts to contain inflation. The RBI will cut rates if inflation behaves as per its projection,” Rangarajan said.
Planning Commission deputy chairman Montek Singh Ahluwalia told reporters: “I think what it signals is that RBI feels that looking ahead, the government has taken many steps which give the fiscal space needed for monetary policy to support growth.”
The rupee rose against the dollar and bond yields dropped, fuelled by the optimism of further monetary easing. The local currency ended the day at 53.76 to a dollar, up 0.28%, while the yield on the 10-year benchmark bond fell 7.84% after opening at 7.9%. Bond prices and yield move in opposite directions.
However, the RBI action failed to cheer stock market investors. BSE’s bellwether equity index, the Sensex, which rose 100 points shortly after the announcement, ended the day 0.56% down at 19,990.90 points, and the bourse’s index of major bank stocks, or the Bankex, also fell 0.5%, as investors rushed to book profits.
More rate cuts
Most economists expect RBI to cut rates again in March, in its next review of the monetary policy, as inflation is expected to fall further.
“We now think that the RBI will likely ease the repo rate by 25 bps in its 19 March policy meeting,” said Tushar Poddar, managing director and chief India economist at Goldman Sachs.
RBI cut the projection for gross domestic product growth in 2012-13 to 5.5% from 5.8% and the estimate of inflation by March-end to 6.8% from 7.5%.
Some economists were, however, sceptical about the central bank’s optimism about a lower inflation. “If the RBI’s past March 2013 7.5% forecast appeared too high, its new 6.8% projection seems too low to us,” said Indranil Sengupta, India economist at Bank of America Merrill Lynch.
According to Sengupta, the central bank is likely to pause in the March policy review, but will go for a 25 bps cut each in May and June policies.
Explaining the rationale behind its action, RBI said it chose to cut rates as “it is critical now to arrest the loss of growth momentum”.
Going ahead, a declining inflation will enable it to ease the monetary policy further, it said. “This provides space, albeit limited, for monetary policy to give greater emphasis to growth risks,” the central bank said, adding that it will do so only if inflation continues to fall.
Inflation, as measured by wholesale prices, fell below 8% for the first time in October after staying above that level throughout the year. In December, inflation fell to 7.18% from 7.24% in the preceding month. More importantly, core inflation, or non-food, non-oil manufacturing inflation, a key indicator of price levels for RBI, has also fallen below 5% in the past two months.
But inflation based on the Consumer Price Index (CPI), or retail inflation, which continues to stay high, is a concern for RBI, economists said. Retail inflation rose to 10.56% in December from 9.90% in November.
Rajeev Malik, senior economist at CLSA Singapore Pte Ltd, said RBI’s forward-looking assessment in the policy statement conveniently ignored the still-high CPI inflation.
“It is difficult to see how inflation expectations of households will ease. The RBI should give greater weight to CPI inflation as it affects inflation expectations and how households assess inflation-adjusted return from bank deposits,” Malik said.
Naresh Takkar, managing director and chief executive of Icra ltd, said space for further monetary easing is limited to 75 bps by September 2013, which will help a revival in growth.
“This policy action is primarily because of the fact that inflation has moderated and is likely to fall even below RBI’s target of 6.8% by March,” said Gaurav Kapur, India economist at RBS.
According to Malik of CLSA, the cut in CRR was surprising “as the key reason for the high deficit in the liquidity adjustment facility is the sharp slowdown in government spending as it attempts to gain credibility by checking the fiscal slippage”.
Due to tight cash conditions in the system, banks have been borrowing an average Rs.80,000 crore daily from RBI. Mirroring the worsening liquidity conditions, bank borrowing shot up to Rs.1.2 trillion from the central bank in December. That apart, banks have also been tapping the refinance facility of RBI.
Also, RBI has infused about Rs.1.3 trillion into the system this fiscal through so-called open market operations, or purchase of bonds from the market.
Industry associations welcomed the twin cuts in repo and CRR and said this will help revive growth in the economy.
“RBI’s decision to ease the monetary policy through a repo rate and CRR cut is a welcome step as it sends out a positive signal that the central bank has now joined hands with the government to revive the growth momentum of the economy, which had so far largely focused on containing inflation,” said Chandrajit Banerjee, director general of the Confederation of Indian Industry.
Naina Lal Kidwai, president of the Federation of Indian Chambers of Commerce and Industry, said the rate cuts “will hopefully help in reversing the anaemic industrial growth observed over the last year”.
PTI contributed to this story.