RBI stuns with big rate cut

The Reserve Bank of India (RBI) surprised everyone on Tuesday by cutting the repo rate, at which banks borrow money from it, by as much as 50 basis points to 8% in an effort to bolster the economy.

This is India’s first rate cut in three years. Problem is, it may be the last for a long time unless, as is popularly suspected happened this time, the government twists the central bank’s arm again.

While the cut sets stage for interest rates on all manner of loans — such as those to buy homes and automobiles — to go down, it won’t happen any time soon.

Experts said it will take at least three months for that to happen because banks can reduce lending rates only when deposit rates fall.

“A decrease in deposit rates is absolutely essential else the cost of funds for banks won’t go down,” said Chanda Kochhar, managing director and CEO, ICICI Bank. Till costs come down, the ‘base rate’ on which banks set their interest rates for loans won’t.

Aditya Puri, managing director, HDFC Bank said banks have to get a significant amount of deposits at lower rates.

“Deposits haven’t been growing and that’s not good for the system. That’s the biggest worry,” Puri said.

India’s largest lender State Bank of India said it will begin cutting lending rates in selective segments.

“The lending rate cut will be particularly in the segments where the mark-up over base rate is significantly more. In our case, it will largely be for small and medium enterprises,” said the bank’s chairman Pratip Chaudhuri.

RBI governor Duvvuri Subbarao said Tuesday’s 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.

“However, it must be emphasised that 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,” he said.

Rajeev Malik, economist at CLSA in Singapore, said the RBI is indicating that there is a limit for further rate cut expectations.
“I think they are pretty much done with further rate cuts this year,” he told Reuters.