Sending a strong signal to banks for a reduction in interest rates and to reverse the trend of declining growth rate,the Reserve Bank of India on Tuesday slashed the repo rate by a higher-than-expected 50 basis points to 8 per cent. However,it ruled out another rate cut in the near future as upside risks to inflation persist,limiting the space for further reduction in policy rates.
Tuesdays was the first cut in repo rate the rate at which the RBI lends funds to banks since April 2009 and came after 13 increases in key policy rate by the apex bank since March 2010 to tame high inflation. As a result,home,auto and corporate loan rates are expected to decline in the coming months.
RBI Governor D Subbarao was hopeful about it today,saying monetary transmission should be quite effective. India Inc and the markets,which were expecting a 25 bps cut,also cheered the surprise margin,with the Sensex rising 207 points to 17,357.94.
Listing reasons for the repo rate cut,Subbarao said,growth decelerated significantly to 6.1 per cent in the third quarter of last year,although it is expected to have recovered moderately in the fourth quarter. The second consideration was the decline in inflation. Headline WPI inflation,which remained above 9 per cent for nearly two years,had moderated significantly to below 7 per cent by March 2012. More importantly,non-food manufactured products inflation dropped from a high of 8.4 per cent in November 2011 to 4.7 per cent in March 2012,coming below 5 per cent for the first time in two years,Subbarao said.
The reduction in the repo rate is based on an assessment of growth having slowed below its post-crisis trend rate which,in turn,is contributing to a moderation in core inflation, Subbarao said. However,the deviation of growth from its trend is modest. At the same time,upside risks to inflation persist. These considerations inherently limit the space for further reduction in policy rates.
The reverse repo rate,or the rate at which the RBI borrows from bank,which is determined with a spread of 100 basis points below the repo rate,has been cut by 50 bps to 7 per cent.
About further rate cuts,Subbarao said: If subsidies are not contained as indicated in the Union Budget last month,demand pressures will persist,and will further reduce whatever space there is for monetary easing. Revisions in administered prices may adversely impact headline inflation.
Subbarao said the appropriate monetary policy response to this should be based on whether the higher prices translate into generalised inflationary pressures. The likelihood of a pass-through of higher administered prices to generalised inflation depends on the strength of the pricing power in the economy. The pricing power is currently abating,but the risk of a pass-through cannot be ignored altogether.
The central bank batted for a hike in fuel prices. Overall,from the perspective of vulnerabilities emerging from the fiscal and current account deficits,it is imperative for macroeconomic stability that administered prices of petroleum products are increased to reflect their true costs of production, the RBI said.
On liquidity management,that posed a major challenge for much of last year,Subbarao said: Liquidity conditions have eased in recent weeks,and are now steadily moving towards the comfort zone of the Reserve Bank. In order to provide greater liquidity cushion,the RBI raised the borrowing limit of banks under the marginal standing facility from 1 per cent to 2 per cent of their net demand and time liabilities,or deposits. It kept the cash reserve ratio unchanged at 4.75 per cent,after cutting it 125 basis points since January.