Scrambling for growth, RBI cuts policy rate

Scrambling for growth, RBI cuts policy rate

Mumbai: After freeing up Rs1 trillion by cutting banks’ cash reserve ratio (CRR), or the proportion of deposits that commercial banks need to keep with it, the Reserve Bank of India (RBI) on Monday slashed its key policy rate for the first time in five years as it attempted to boost investment and stoke slowing economic growth.

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RBI reduced the repo rate, or the rate at which it infuses money into the financial system, by 100 basis points to 8% in an effort to lower borrowing costs and ease a credit crunch, boosting the stock and bond markets and pushing the rupee further down.

One basis point is one-hundredth of a percentage point.

RBI, which announced the move four days ahead of its mid-term monetary policy review, also cancelled a Rs10,000 crore bond auction to maintain liquidity in the system. Bankers said it would take time for commercial banks to pick up the cue and lower borrowing costs.

“I hope this will enthuse investors to continue to take forward their investment proposals," finance ministerP. Chidambaram said. The cut will ensure “satisfactory growth".

Bankers and bond dealers expect RBI to pursue an accommodative monetary policy by announcing more rate cuts in the coming months as it tries to shield the economy from global financial market turmoil and open up the liquidity tap, after striving for months to contain inflation.

Also See: Easing Pressure (Graphic)

“With this move, RBI has decidedly come on the side of growth and financial stability against inflation and we expect this bias to continue," said Goldman Sachs Group Inc.’s Asia Policy Watch, released after the rate cut announcement.

India’s bellwether equity index, the Bombay Stock Exchange’s Sensex, gained 247.74 points, or 2.48%, to close at 10,233.09 on Monday, ending a three-day losing streak that saw it fall below the 10,000 level on Friday. The 50-share Nifty of the National Stock Exchange gained 48.45 points, or 1.6%, to 3,122.80.

The bond market also cheered the rate cut, with the yield on the 13-year bond falling to 7.78% from 8.7% on Friday. But the rupee slipped to a new six-year low of 49.0125 to a dollar. According to foreign exchange dealers, a lower interest rate makes India a less attractive bet for foreign investors who come to the country to benefit from interest rate arbitrage.

The rate cut may not immediately lower the cost of bank loans for companies or individuals, some bankers said.

“We are looking into the situation. Rate cut alone cannot bring down the lending rates. We need to see the liquidity situation," said O.P. Bhatt, chairman of State Bank of India, the country’s largest lender.

Chanda Kochhar, joint managing director of ICICI Bank Ltd, India’s largest private sector lender, said the rate cut clearly signifies an easing of monetary policy “but the impact on lending and deposit rates will have to be seen over time".

Keki Mistry, vice-chairman and managing director of Housing Development Finance Corp. Ltd, the country’s oldest mortgage firm, said it would take some time for the impact of the cut to be felt.

K.C. Chakrabarty, chairman and managing director, Punjab National Bank, was noncommittal on an immediate rate cut. “We have already cut our retail loan rates, but whether we will reduce our corporate loan rates depends on the market confidence," he said. “Unless stability comes into the market, it’s difficult to take a view."

However, chairman and managing director of Bank of BarodaM.D. Mallya said the cut “gives us a repricing opportunity".

Stating that it’s a clear signal where interest rates are heading, Mallya said his bank will assess the situation and take a call on a rate cut soon.

The last time RBI cut its policy rate was in August 2003. In March 2004, the repo rate, or the rate at which RBI injects money into the system, came down by 100 basis points, not because of a rate cut but because of a compression of the spread between the repo rate and reverse repo rate, or the rate at which RBI sucks out liquidity from the system.

In a liquidity-surplus situation, the reverse repo is the policy rate, but when liquidity dries up, the repo becomes the policy rate. In March 2004, the reverse repo was the effective policy rate.

“India is experiencing the indirect impact of the global liquidity constraint as reflected by some signs of strain in our credit markets in recent weeks," RBI said. “In order to alleviate the pressures and, in particular, to maintain financial stability, RBI has decided to reduce the repo rate...with immediate effect.’’

The statement added that RBI will monitor the impact of global developments on the financial markets and liquidity conditions and will take appropriate action.

RBI might cut its policy rate by another 100 basis points by January, according to A. Prasanna, chief economist at ICICI Securities Primary Dealership Ltd, that buys and sells government bonds.

“Economic slowdown has already set in and the rate cut will help in shortening the length of slowdown," Prasanna said.

The primary dealer expects the government to cut petrol prices soon and wholesale price inflation to decline to 5% by March.

The wholesale price-based index eased to 11.44% for the week ended 2 October, the lowest level in four months.

“It is encouraging that despite inflation, money supply and credit growth being ahead of targets, the Reserve Bank of India has shifted the focus to growth," said Rohini Malkani, economist at Citigroup Inc.’s Indian unit. “The cut in the repo rate will eventually result in bringing down funding costs, which is crucial for stemming the deceleration in investment growth."

Graphic by Sandeep Bhatnagar / Mint