RBI Cuts Key Interest Rates; Repo Rate, Reverse Repo, CRR Cut By 25 Basis Points To Boost Economic Growth

The Reserve Bank of India in its third quarter monetary policy review Tuesday cut the key interest rates for the first time in nine months in an attempt to boost the economic growth, which has hit a decade low.

RBI cut the policy repo rate - the rate at which the RBI lends money to commercial banks - by 25 basis points from 8.0 percent to 7.75 percent as expected and reverse repo rate - the rate at which the RBI borrows money from commercial banks - to 6.75 percent from 7.0 percent.

A reduction in repo rate makes the loans that the banks borrow from RBI cheaper. The decline will also prompt the banks to slash the lending rates on loans to customers as the banks fix their interest rates based on the repo rate.

The central bank also reduced the cash reserve ratio - the amount of funds that the scheduled banks have to keep with the RBI - by 25 basis points from 4.25 percent to 4 percent of their net demand and time liabilities (NDTL) effective the fortnight beginning Feb. 9, 2013.

The unexpected move to reduce the CRR will infuse an additional 180 billion rupees into the banking system, as the banks have to keep lower cash reserves with the Central Bank.

The much-awaited rate cuts came amid fears of an escalation in inflation rate due to spiraling food and fuel prices in the current month.

However, the RBI in a statement said that it had to strike a balance between the conflicting pressures from high inflation and a need to increase liquidity and funds flow to boost the economic growth, while deciding to review the monetary stance.

The RBI stated it decided to cut the rates after taking into account the softening in non-food manufactured products inflation and lackluster investment outlook in the country, which demanded loosening of the monetary policy.

“With headline inflation likely to have peaked and non-food manufactured products inflation declining steadily over the last few months, there is an increasing likelihood that going into 2013-14, inflation will remain range-bound around the current levels. This provides space, albeit limited, for monetary policy to give greater emphasis to growth risks,” RBI said giving its guidance.  

According to the analysts, through the moderate rate cuts, RBI has cautiously attempted to bring in a balance between the inflationary pressures and economic growth.    

"RBI has not abandoned its cautious stance, stressing on the 'calibrated and limited' nature of rate support (from) hereon," Radhika Rao, economist, Forecast Pte in Singapore told Reuters.

"The scale of rate cuts is closely tied to the government's sustained efforts to correct the twin imbalances and moderating inflation trajectory."

The Central Bank however reiterated its concerns over a ballooning fiscal and current account deficits (CAD).  

"Financing the CAD with increasingly risky and volatile flows increases the economy's vulnerability to sudden shifts in risk appetite and liquidity preference, potentially threatening macroeconomic and exchange rate stability," the RBI said.

The central bank had kept interest rates on hold as inflation remained stubbornly high despite repeated calls from the government and industry for a cut. The last rate cut in April saw RBI slashing the repo rate by 50 basis points.

Indian stock markets remained rangebound Tuesday morning after the Reserve Bank of India (RBI) cut its key interest rates for the first time in nine months to boost the economic growth. However, the banking stocks traded higher boosted by the rate cuts.