RBI springs surprise, cuts repo by 50 bps By Dinesh Unnikrishnan & Anup Roy Indias central bank unexpectedly

slashed its key lending rate by half a percentage point on Tuesday, to support growth in Asias third largest economy, marking the reversal of its monetary policy stance that has focused on containing inflation in the past three years. Click here to read full story

The rate cut, if not anything else, will act as a sentiment booster.

It will help small and medium firms that operate on the fringe and will help banks to contain their NPAs. However, it will take some time before banks begin to lower their lending rates as such decisions will be governed by their cost of funds which, in turn, will be guided by the evolution of liquidity conditions.

Inflation target
Higher growth is analogous to a rising tide which lifts many boats. The monetary policy measure announced on Tuesday is supportive of private investment. However, the growth trajectory will be ultimately governed by complementary fiscal policies and structural reform measures to ease supply-side constraints. If the Government allows the prices of petroleum products to be aligned with international prices, it will have inflationary implications. If the Government decides to absorb the rise in prices, the fiscal deficit will shoot up, which, again, will not only be inflationary, but will also crowd out private investment and affect growth adversely. The RBI has projected for a WPI inflation target of 6.5 per cent for March 2013. This target appears ambitious as there are significant upside risks to inflation in the economy. The 50 bps cut perhaps is recognition on the part of the central bank that further rate cuts will be few and far between, unless growth decelerates significantly. (The author teaches Economics at the Xavier institute of Management, Bhubaneswar. ) (This article was published on April 18, 2012) Keywords: RBI, rate cut, Interest rates, repo rate, Inflation, growth, monetary policy

RBI credit policy: Five ways the repo rate cut affects you
NDTV Correspondent, 18 Apr 2012 | 08:07 AM

The surprise 0.5 per cent cut in repo rate, the rate at which Reserve Bank of India lends to banks, should trigger an across-the-board cut in lending rates by banks. Consumers need to strike borrowing deals quickly now as RBI continues to remain wary of a spike in the inflation rate. This should restrict RBIs ability to make sharp cuts in the future.

Here are five ways the credit policy affects borrowers: Floating rate loans get cheaper: The rate cut is passed on by banks to consumers. If you are on a floating rate home loan, you can expect a cut in the interest rate the bank charges on it. So ensure that you cut the number of equated monthly installments (EMI) or the tenure of your loan to get the benefit of low interest rates. Prepayment penalty abolished: RBI has barred all banks from charging any prepayment penalty on home loans. Some banks had already voluntarily stopped charging pre-payment penalties. However, RBI has taken a view that there was a need for uniformity to ensure banks offer competitive rates to consumers.

Auto, personal loans cheaper: For new loans at a fixed rate such as autos, consumer durables or personal loans, banks are likely to offer new financing packages. It is important that you negotiate with your bank to get the benefit of the cut in interest rates. While banks typically quickly pass on the benefit of the rate cut to home loan borrowers, the process is usually slower for consumer loans. It is important that you let the bank know that you are aware that the cost of money for banks has gone down.

Fixed deposit rates could fall: Banks could reduce long-term fixed deposit rates as short-term deposit rates could go up. However, this is unlikely to be significant as RBI expects the deposit growth to lag the credit growth. This means RBI needs banks to have sufficient deposits to meet the demand for credit. So, banks would not be in a hurry to cut deposit rates sharply.

Sharp rate cuts unlikely: No sooner than the RBI announced a higher than expected rate cut that share prices surged. This is because low interest rates mean low cost of capital and improvement in profits. However, with inflation staying high, RBI is unlikely to continue cutting rates. The stock market fell from its intra-day high and the BSE Sensex traded flat as traders read through the credit policys fine print. According to rating agency CRISIL, a significant reduction in lending rates in the current financial year is unlikely due to less availability of funds in the system or liquidity, higher government borrowings and high cost of deposits. For the whole year to March 2013, CRISIL expects a rate cut of 0.5 per cent.

If numbers change, there will be scope for more rate cuts: D Subbarao
Manojit Saha / Mumbai 18 Apr 12 | 12:58 AM

RBI governor Duvvuri Subbarao hopes the first interest rate reduction in three years will do its bit to revive growth and investment. In an interview with Manojit Saha, he says he is fairly confident banks will respond, even if with a lag. Edited excerpts: The mid-quarter statement of the RBI in March was seen as a hawkish stance. The sentiment was also evident in the bond market, as yields rose. What changed in the past month that prompted a more-than-expected rate cut? Expectations dont influence our decision. What changed between March 15 and April 17 is that, first, we had the IIP numbers that showed industrial production had gone down much more than expected earlier and the growth for last year would have been 6.9 per cent, as projected by the CSO. Inflation numbers that came yesterday showed headline inflation has gone down but core inflation has gone down much more (below five per cent for the first time in two years). These were the two main dimensions that influenced the policy decision. In the macroeconomic and monetary development report released on Monday, it was said the policy stance was neutral. With todays rate cut, can we say the policy stance is accommodative? No. I believe todays rate action reflects todays growth-inflation dynamics. You cannot say we are in an accommodative stance now. We are at the appropriate stance as required by the growthinflation numbers, as we expect these to roll out in the next one year. You have said there is limited scope for a further rate cut. Does that mean there is still scope for a rate cut? Yes, of course. It does mean that. These are not cast in stone. We said the probability for further action is limited because the economy will be growing at 7.3 per cent this year, just short of the trend rate of growth. So, the output gap might be closed. But, if these numbers change, there will be scope for further rate cuts. If the inflation forecast for March-end is 6.5 per cent, then why is the scope limited? Our projections for growth and inflation have been factored in our action today. So, if we do have to do further easing, we necessarily have to reckon with inflationary expectations. What is your corridor or comfort on real policy rates? We don't have a corridor or a comfort. But, real policy rates were negative until recently and just about became positive. While we don't have a target, we look at it as one of the variables that go into our policy analysis. In case inflation moves up during the course of the year, will the RBI change its inflation forecast and tighten monetary policy? It depends on what the drivers of inflation are and how we see them rolling out. If the drivers are one-off shocks, then there is no need for a policy response. But if it is a persistent shock, then of course the headline will translate into generalised inflation and then we will have to respond.

How confident are you that the rate cut will support growth? Quite confident, because one of the motivations for easing monetary policy is to revive investments. We had said that monetary tightening was not the only factor behind an investment or growth downturn. There were other factors like domestic policy and governance issues, but in as much as the monetary policy is one of the factors, we hope our easing will encourage investment and generate a supply-side response, both to raise growth and keep inflation down. What are the possible tools the RBI can employ if global capital inflows dry up? I cant really speculate what we might do but we will try our best to mitigate the risk factors and to bring in comfort or reduce the discomfort. But, ultimately, balance of payment (BoP) pressures cannot be mitigated by fixes but fundamental changes have to take place to make exports competitive, make imports price-elastic and get capital flows of more durable variety like FDI. Ultimately the BoP issues will have to be addressed by deep-rooted reforms. How credible was the road map on fiscal consolidation presented in the Budget? We have to take them at face value. The finance minister said he would bring in new FRBM, he would cap subsidies at two per cent of GDP, and that they are working on DTC and GST, which are going to be game-changers in many ways. So, I think if all these things are carried through, the road map will be credible. Deposit growth in the banking system came down sharply last financial year, except for the last week. What was the reason for that? When we spoke to banks today, they said they had been crowded out, with competitive instruments like small savings and by tax saving bonds came to the market, where the post-tax yields are much more attractive than banks. So, as we have reduced rates, banks might respond with reducing their deposit rates and we hope other instruments in the market should respond likewise. It cannot be the case that one segment of the market is fixed and the other segment is flexible. The entire market has to be flexible. Are you confident of monetary transmission? Fairly confident, I should say. I heard the banks say transmission would take place but, probably, it might happen with a lag. We leave it at that.

Business | Updated Apr 17, 2012 at 04:23pm IST

Sensex ends 207 points up on repo rate cut