The Reserve Bank of India (RBI) in its third quarter monetary policy review obliged with a 25 basis point repo rate cut, first repo rate cut in nine months. The repo rate now stands at 7.75%. The bank also cut the cash reserve ratio by 25 basis points to 4%. The move is meant to infuse Rs 18,000 crore into the banking system. While repo rate cut will reduce the cost of borrowing for individuals and corporates, the reduction in CRR, which is the portion of deposits that banks have to park with RBI, would improve the availability of funds. The stance of monetary policy in this review is intended to provide an appropriate interest rate environment to support growth as inflation risks moderate," Subbarao said while unveiling the policy review. The RBI, however, has reduced the growth projections for the current financial year to 5.5 per cent from its earlier estimate of 5.8 per cent. While it is also flagged of the risk of twin deficit on account of widening current account deficit and fiscal deficit amidst a slowdown in the economy. On inflation, it moderated the rate to 6.8 per cent for March-end from earlier projection of 7.5 per cent. The central bank's policy decision is against the backdrop of slowing economy and easing of inflation pressures. However at the same time, with deposit growth in the banking system lagging the credit growth, there could be some obstacle in passing on rate cuts as banks' face a risk of a squeeze in deposits if they reduce rates further. So far, credit has grown 16.3% year-on-year, which is with the central bank's comfort zone of 16% for the year. But deposits have grown by 13.3%, way below the central bank's comfort zone of 15% for the year.
C V R Rajendran, executive director of Bank of Maharashtra said that a cut in lending rates will happen only after deposits rates are lowered." However at present, lowering deposit is a challenge given that deposit growth is slower than the advances growth. The action taken by large players wills the deciding factor for the industry." Though a rate cut should help lower cost of borrowing on the assumption that banks will cut lending rates, there could challenges. For one, borrowing decision for investments depend on a host of other policy factors and the overall investment climate. For the bond market, which have been plagued with liquidity constraints, the central bank might have done with CRR cuts. Going ahead, dealers expect that the central bank to handle liquidity issues through open market operations or OMOs.
From hereon we do not expect any more CRR cuts over the next six months the central bank would rely on open market operations." said A Prasanna, economist at ICCI Securities Primary Dealership
On the eve of the keenly expected review, the central bank, struck a hawkish tone on the state of fiscal and current account deficits, appearing to throw into question even the much-expected 25-basis-point reduction in rates. "Given the preponderance of non-monetary factors behind the current slowdown in an environment where risks from high inflation, current account and fiscal deficits still remain, the scope for supportive monetary policy action is constrained," said RBI's Macroeconomic and Monetary Developments Third Quarter Review. "As reform actions get executed, monetary policy could increasingly focus on growth revival." The central bank's cautious tone came as Finance Minister P Chidambaram sought to woo investors in Frankfurt with prospects of lower interest rates reviving economic growth as price acceleration is slowing. The government has made no secret of its desire to see lower rates in the past, and RBI's reluctance to oblige has been a major point of discord between the two. Last October saw an unprecedented display of irritation by the finance minister at RBI, which did not cut rates against the government's wishes.
Source: Economic Times
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