RBI blinks on rate cut, banks take the cue

Repo rate reduced 25 bps after 8 months CRR at record low, but central bank strikes cautious note on further easing

P Chidambaram will not have to walk alone on growth anymore. Two months after the finance minister made a public statement on his disappointment over the Reserve Bank of India’s (RBI’s) refusal to reduce interest rates, Governor D Subbarao has finally blinked.

RBI on Tuesday not only lowered its key policy rate (by 25 basis points to 7.75 per cent), for the first time in nine months but also offered a bonus by reducing the cash reserve ratio, the share of deposits banks must keep with the central bank, by an equal amount. 

The CRR cut to four per cent — an all-time low — will infuse an extra Rs 18,000 core into the banking system.
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Multimedia | Editor's Take: RBI Q3 Monetary Policy Review

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RBI, however, has struck a cautious note on further easing as it waits to see how the government’s coming Budget aims to bring a bloated fiscal deficit under control. While noting there was a likelihood that inflation would remain range-bound around the current level entering the new financial year, RBI said: “This provides space, albeit limited, for monetary policy to give greater emphasis to growth risks.”

The central bank stressed halting a slide in growth had become critical but went on to list constraints, notably the high current account and fiscal deficits, and the risk that inflation could flare again.

But in the short term, there’s good news for customers as banks are set to reduce their base rate, which will reduce interest rates across the board. “We would do full monetary policy transmission and cut the cost of capital,” State Bank of India Chairman Pratip Chaudhuri said.

Public sector lender IDBI Bank has already reduced its base rate by 25 bps to 10.25 per cent and some deposit rates by the same measure. Some bankers, however, say their deposit rate might come down only after a lag.

“There will be transmission on the lending side. On the deposits side, we’ll be watching the situation” said ICICI Bank MD & CEO Chanda Kochhar. “Clearly, in the long term, banks cannot take a hit on their margins and the lag will get adjusted,” she added, indicating deposit rates would go down after a lag.

Subbarao told reporters at the post-policy press conference, if inflation and the current account deficit moderated more than the central bank’s expectations, there would be more room for monetary policy easing. “But if they go along the currently expected lines, the scope for monetary policy easing is quite limited,” he added.

A relieved India Inc welcomed the move, saying the cut in CRR would ease fund flow. CII President Adi Godrej said industry appreciated the RBI signal that it was ready to promote growth, in addition to anchoring inflationary expectations. In terms of quantum, industry would have appreciated a higher repo rate cut, he added.

Markets were, however, not too enthused as the rate cut, which was on expected lines, had already been factored in, though the CRR cut came as a surprise. The Sensex fell to a one-week low on Tuesday, led by a decline in rate-sensitive stocks, as RBI was cautious on future rate cuts.