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RBI Looks to Power Growth, Cuts Rates

Looking to escape the clutches of the global financial crisis, the RBI, on Tuesday cut its key short-term rates

With most experts divided equally over whether there would be rate cuts at the Reserve Bank of India’s (RBI) annual policy review meeting, the central bank set to rest all speculation and opted for a strategy that would spur growth—maintaining status quo was not seen as the way forward, in spite of many financial pundits foreseeing the same.

In fact, with India in the midst of a general election, all the other options available to the country’s policy makers were irrelevant, and the only other available alternative to boost spending was a pro-active role for the RBI, to power faltering growth in the face of the global financial crisis.

A poll conducted by Reuters on Monday showed that the analyst community was split down the middle on whether RBI will cut its key lending rate on Tuesday.

A Dow Jones poll, where some 18 experts were quizzed on the subject, indicated by a majority of 10 that the central bank is expected to keep rates on hold.

Today, RBI cut the repo rate by 25 bps (basis points) and reverse repo by 25 bps; leaving the other two policy variables – cash reserve ratio (CRR) and statutory liquidity ratio (SLR) untouched (The central bank uses these tools either to inject liquidity into the system or take it out as it deems fit in a given situation).

Among the many pressures-points on the RBI to cut rates, one of the most pressing was that inflation was likely to turn negative in the very near future and something had to be done to prevent that eventuality from occurring. However, the RBI has projected inflation to hold steady within a band of 3-to-4%.

RBI has more or less toed the much-publicized line of the Centre, that there is much scope yet to cut the prime lending rate, keeping in view that most of the developed countries’ central banks have opted to wield the axe on rates quite freely to escape the effects of the global meltdown.

In a recent conversation with top businessmen, Prime Minister Manmohan Singh categorically said: “With ample liquidity and low inflation, there is scope perhaps for further moderation in interest rates”.

With the real interest rate still hovering around 12 per cent, there was little RBI could do to avoid this rate cut. It was under increasing pressure to force the domestic banks into lending, as they were parking their extra cash with the RBI—for the past couple of weeks, on an average, over Rs 100,000 cr was stashed away in RBI.

The RBI, on Monday, had already painted a bleak picture, saying economic growth would be moderate in the face of the global crisis. The economic growth rate forecast by the RBI for the current fiscal is 6%, while it was estimated at 6.5-6.7% for 2008-09.

Since October 2008 this is the sixth such instance when the RBI has slashed the policy rate. With the most recent rate cut on Tuesday, the total reduction in policy rate comes out to 425 bps.


History of Rate Cuts
  Repo  bps  Reverse Repo  bps
20/10/2008 9.0 -100 6.0 0
03/11/2008 8.0 -50 6.0 0
08/12/2008 7.5 -100 6.0 -100
02/01/2009 6.5 -100 5.0 -100
04/03/2009 5.5 -50 4.0 -50
21/04/2009 5.0 -25 4.0 -25

Highlights
Repo rate cut by 25 bps to 4.75%, reverse repo rate reduced by 25 bps to 3.25%

RBI to keep current foreign bank policy.

Cash reserve ratio left unchanged at 5%

Money supply growth for 2009/10 at 17%

Accounting method of savings bank interest rate to be changed from Apr 2010.

Interest payment on savings bank accounts to be calculated on daily pdt basis.

FCCB buyback limit increased to $100 million

Extends relaxation on ECB all-in-cost ceiling

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Extends special refinance facility, special term repo facility to March 31, 2010