RBI surprises market with cut in short-term rates

Central bank forecasts GDP growth at 6%, inflation at 4% for 2009-10.

Two of the country’s largest private sector banks — ICICI Bank and HDFC Bank — today reduced their rates, after the Reserve Bank of India (RBI) surprised the Street with a 25 basis points cut in the repo and reverse repo rates.

Projecting gross domestic product growth at 6 per cent for the current financial year, RBI lowered the repo rate to 4.75 per cent and the reverse repo rate to 3.25 per cent, which is 25 basis points lower than the interest rate paid on funds lying in savings bank accounts. The moves are aimed at spurring economic activity and consumer demand.

In its annual policy statement for 2009-10, the central bank also said the transmission of the measures already announced by it since September has not taken place and there was room for banks to lower rates further.

Since the credit crisis intensified, RBI has used all tools at its disposal to inject nearly Rs 4,63,000 crore liquidity into the system and has signalled a softer interest rate regime by paring repo and reverse repo rates 425 basis points and 175 basis points, respectively (see chart).

It also cited low inflation to make its case for further rate cuts. RBI has projected that inflation would rise to around 4 per cent by March 2010 but could fall into negative territory in the early part of the current financial year. “However, this should not be interpreted as deflation for policy purposes.

This expected negative inflation in India has only statistical significance and is not a reflection of demand contraction as is the case in advanced economies. This transitory WPI inflation in the negative zone may not persist beyond the middle of 2009-10,” the central bank said.

“Inflation risks have clearly abated… Banks should not be overly apprehensive about reducing deposit rates for fear of competition from small savings, especially as the overall systemic liquidity remains highly comfortable. There is scope for the overall interest rate structure to move down,” RBI Governor D Subbarao said.

By evening, ICICI Bank, the second largest private sector lender, said that it would lower its benchmark lending rates for retail and corporate clients 50 basis points from tomorrow. Deposit rates will be pared 25 to 50 basis points from Friday.

ICICI Bank reduced the floating reference rate (FRR) for consumer loans, including home loans, from 13.75 to 13.25 per cent. The lender said all the existing floating rate customers would benefit from the reduction in rates.

An HDFC Bank spokesperson said it would lower deposit rates 25 to 35 basis points, but remained non-committal on further reductions in lending rates. Other banks also said they would wait before deciding on further rate cuts.

“There could be moderation in lending as well as deposit rate on the RBI policy signals. Our Alco (asset-liability committee) will decide the amount and the effective date,” said Bank of Baroda Chairman and Managing Director M D Mallya.
 

How banks have responded
Deposit rates	Oct, 2008 (%)	Apr, 2009 (%)	Variation (bps)
PUBLIC SECTOR BANKS
Up to 1 year	2.75-10.25	2.75-8.00	0-225
1-3 years	9.50-10.75	7.00-8.75	200-250
Over 3 years	8.50-9.75	7.25-8.50	125-125
PRIVATE BANKS
Up to 1 year	3.00-10.50	3.00-8.50	0-200
1-3 years	9.00-11.00	7.50-9.50	150-150
Over 3 years	8.25-11.00	7.50-9.25	75-175
5 MAJOR FOREIGN BANKS
Up to 1 year	3.50-9.50	2.50-8.00	100-150
1-3 years	3.60-10.00	2.50-8.00	110-200
Over 3 years	3.60-10.00	2.50-8.00	110-200
PLR*	Oct, 2008 (%)	Apr, 2009** (%)	Variation (bps)
Public sector banks	13.75-14.75	11.50-13.50	125-225
Private banks	13.75-17.75	12.50-16.75	100-125
5 major foreign banks	14.25-16.75	14.25-15.75	0-100
* Prime lending rate                   ** Up to April 18                                  Source: RBI

“We have just cut our deposit rate 75 basis points effective April. We will take a call on reducing lending rates when our Alco meets next week. Slashing deposit rates further is not on the cards right now,” added a senior Bank of India executive.

RBI opted for further cuts as it estimated the economy to grow 6.5 to 6.7 per cent in 2008-09 against growth of 8.9 per cent in the preceding five years. Besides, with the global economy unlikely to recover, RBI is trying to get banks to fill the gap in flow of resources to the commercial sector.

Besides, the central bank also tried to comfort the market by saying that it would manage the government’s large borrowing programme in a non-disruptive manner, though it would be a major challenge. RBI said that it would use a mix of monetary and debt management tools to ensure this was done smoothly.

Yield on 10-year government securities fell 21 basis points to 6.18 per cent, the lowest level in nearly six weeks. The rupee, however, weakened to 50.45 against the US dollar at close of trade today, as against 50.33 yesterday. In the equity market, banks stocks bore the brunt as the benchmark indices fell for the second day.

There was, however, little good news for foreign banks as RBI decided to maintain status quo on the review of the guidelines for foreign banks. At present, RBI allows restricted entry for foreign banks with shareholding limited to identified banks. The policy was due for review in April, 2009 but the regulator decided to defer it till the global economic environment improved.