The Reserve Bank of India (RBI) on Tuesday cut the repo rate — its key lending rate-— and the cash reserve ratio or the proportion of deposits that banks have to park with the central bank, by 0.25% points each. It however obliquely cautioned that a turnaround in the economy was still some distance away.
“Economic activity has slowed, trailing well below its potential and opening up a negative output gap,” said D Subbarao, RBI governor, in the third quarter monetary policy review. “What the economy needs most of all and most urgently is new investment.”
The rate cut, the first in nine months, came after India’s wholesale price inflation reached a three-year low of 7.18% in December, which the central bank said would fall further to 6.8% by end-March.
A lower repo brings down borrowing costs for banks, prompting them to slash interest rates for final home, auto and corporate borrowers.
Besides, a lower CRR will leave banks with additional Rs.18,000 crore to lend to consumers.
Both these measures, it is expected, should goad banks to slash lending rates.
The RBI uses monetary tools to stymie demand and cool prices. The tug-of-war between sliding growth and rising inflation, which has forced the RBI keep interest rates high, has hurt consumption demand, the foundation of India’s growth.
India’s factory output contracted by 0.1% in November, mirroring weak investment activity as firms hold back capacity expansion plans.
The RBI said India’s GDP will grow a slower clip of 5.5% in 2012-13, the lowest in 10 years and lower than the central bank’s earlier forecast of 5.8%.
“While the series of policy initiatives by the government has boosted market sentiment, it will take some time to reverse the investment slowdown and reinvigorate growth,” RBI said.
“The decline in the GDP (Gross Domestic Product) growth rate became more broad based, with consumption demand also slowing alongside stalling investment and declining exports,” Subbarao said.