RBI may cut repo by 25bps

RUN-UP TO MONETARY POLICY

The Reserve Bank of India (RBI) may opt for a 25 basis point cut in the repo rate, to prop sagging demand in the interest rate-sensitive durables sector in the mid-term review of its 2007-08 monetary policy on October 30.

On the other hand, the central bank is not expected to raise the cash reserve ratio (CRR), the proportion of deposits banks have to keep with the central bank, though the continuing surge in foreign capital inflows warrants an increase.

The likely reduction in the repo rate would take place despite concerns about inflation, which suggest that interest rates can be left unchanged, banking sources said.

Though wholesale price inflation has dropped closer to 3 per cent against the RBI's target of up to 5 per cent, inflationary concerns persist because of high commodity prices, particularly with oil prices at above $80 per barrel, and high asset prices.

Also, lower inflation in the recent period has also been on account of the base effect -- that is, high prices a year ago.

The repo or the repurchase rate is the rate at which the central bank lends short-term money to banks against government securities. It is a tool for infusing liquidity in the system, which can potentially spur inflation. The reverse repo is the mechanism for absorbing surplus funds from the system.

The reverse repo rate has been maintained at 6 per cent since July 2006, but the repo rate has been raised three times by a cumulative 75 basis points to 7.75 per cent.

Any reduction in the repo rate leading to slightly higher growth in credit demand should not concern the central bank since the rise in credit offtake has slowed to 22 per cent in the first half of 2007-08 against its target of 25 per cent for the year.

On the issue of CRR, sources said, "It is a matter of time before the RBI uses CRR. At present, the situation seems to be manageable and RBI could wait for a while."

Foreign exchange inflows are expected to continue despite the measures taken by the Securities and Exchange Board of India to stem the flow of foreign investments in equities through participatory notes. This could continue to be a source of liquidity in the system.