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Posted on Jan 29, 02:11PM | IBNS
The Reserve Bank of India (RBI) on Tuesday announced reduction of its policy repo rate by 25 basis points along with Cash Reserve Ration (CRR) rate, a move for the first time in past nine months that is aimed at boosting slow economic growth.
"Based on an assessment of the current macroeconomic situation, we have decided to reduce the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis points from 8.0 per cent to 7.75 per cent," said RBI governor D Subbarao.
Consequent to this, the reverse repo rate under the LAF, determined with a spread of 100 basis points below the repo rate, gets calibrated to 6.75 per cent. Similarly, the marginal standing facility (MSF) rate, determined with a spread of 100 basis points above the repo rate, and also the Bank Rate stand adjusted to 8.75 per cent.
These changes have since come into effect immediately after the announcement.
"We have also decided to reduce the cash reserve ratio (CRR) of scheduled banks by 25 basis points from 4.25 per cent to 4.0 per cent of their net demand and time liabilities (NDTL) effective the fortnight beginning February 9, 2013," said Subbarao.
"This reduction in the CRR will inject primary liquidity of around Rs 180 billion into the banking system," he said.
RBI said the decision to further ease the monetary policy stance was informed by three considerations.
"First, both headline wholesale price inflation and its core component, non-food manufactured products inflation, have softened through the third quarter. This provided some relief from the persistence that dominated the first half of the year. Several indicators such as the weaker pricing power of corporates, excess capacity in some sectors, the possibility of international commodity prices stabilising as well as inflation momentum measures suggest that inflationary pressures have peaked," said Subbarao.
"However, further moderation in inflation going into the next fiscal year is likely to be muted as the correction of under-pricing of administered items is still incomplete and food inflation remains elevated. Accordingly, the setting of monetary policy has to remain sensitive to these conflicting pressures and attendant risks," he said.
"Second, growth has decelerated significantly below trend through the last fiscal year and through this year so far, and overall economic activity remains subdued. On the demand side, investment activity has been way below desired levels and consumption demand too has started to decelerate. External demand has also weakened due to languid global growth.
"On the supply side, constraints in the availability of key raw materials and intermediates are becoming binding. While the series of policy measures announced by the Government has boosted market sentiment, the investment outlook is still lacklustre, especially in terms of demand for new projects," he said.
The third consideration that informed RBI decision is that liquidity conditions have remained tight.
"Although the Reserve Bank lowered the cash reserve ratio, CRR, successively in September and October 2012, and carried out open market operations (OMO) injecting systemic liquidity of '470 billion during December and January to augment liquidity, the average net LAF borrowings at '910 billion in January have been above the Reserve Bank's comfort level.
"This tightness could potentially hurt credit flow to productive sectors of the economy. The structural deficit in the system provided a strong case for injecting permanent primary liquidity into the system," said Subbarao.
Indian Inc reacted positively to the cuts.
Reacting to the cuts, Seshagiri Rao, JMD and Group CFO, JSW Steel said: "It was much needed given that the GDP growth is moderating and industrial production is decelerating month after month."
Reserve Bank of India (RBI) rate cut is an encouraging move at a time when high interest rates were having negative impact on the country's economic growth, he said.
"There are tight liquidity condition in money market as reflected by borrowings under repo window over Rs.1,00,000 crore. More liquidity injection by RBI is the need of the hour as 0.25pc CRR cut releases only Rs.18000 crores. The transmission of lower interest rate to borrowers in response to cut in repo rate should take place swiftly as the banks have already reduced deposit rates for the past few months," he said.