The Reserve Bank of India (RBI) on Tuesday cut its key lending rate—the repo rate—by 0.25 percentage points to 7.25% rekindling hopes of lower home loan EMIs and cheaper bank capital for companies to invest and hire more.
RBI governor Raghuram Rajan, however, kept two key main rules unchanged, disappointing markets, which were expecting the central bank to cut the statutory liquidity ratio (SLR) and the cash reserve ratio (CRR) that would have given banks more funds to lend and enable them to lower loan rates by a higher extent.
The benchmark 30-share BSE Sensex fell by over 300 points shortly after the RBI announced its policy.
The SLR, the proportion of deposits banks are required to park in government bonds, stands at 21.5%, while the cash reserve ratio (CRR), the proportion of deposits that banks have to park with the RBI, stands at 4%.
The repo rate cut, however, will likely goad companies to invest, add capacities, hire more, and prompt people to spend on houses, cars and other goods and aid the budding recovery in Asia’s third largest economy.
A lower repo will bring down banks’ borrowing costs, which in turn, may prompt them to slash their “base rates”, the floor interest rate on which lending rates for final home, auto and corporate borrowers are fixed.
A lower repo can lead to lower floating home loan rates, which move in tandem with base rates, and bring cheer to consumers, who have been paying large chunks of their income every month towards repaying housing loans.
This is the third rate cut by RBI since January largely aided by low inflation rates signalling a subtle change in RBI’s stance from steadfast focus on controlling prices to aiding growth.
India's current retail inflation, the RBI’s main guide for interest-related decisions, stood at a four-month low of 4.87%, giving more room for the RBI to cut interest rates.
Rajan, had kept rates unchanged in April but told banks in no uncertain terms that it was about time they start reducing interest rates to pass on two previous cuts to customers.
Many lenders including in State Bank of India (SBI), ICICI Bank and HDFC Bank have announced cuts in their “base rates” in April leading to a fall in EMIs for some class of existing as well as new borrowers.
On Tuesday, Rajan again asked banks pass on the latest repo rate cut in the form of cheaper loans for consumers.
Also, the RBI said it will likely keep a close watch on the monsoon rains this year in the backdrop of the prediction of a below-normal monsoon for the second year.
The central bank expects inflation rates to creep up to 6% by January 2016, from the earlier forecast of 5.8%, on the back of deficient summer rains and higher service tax rates that has been raised to 14% from 12.36% earlier.
On growth, the RBI expects GDP to grow at 7.6% in 2015-16, down from the earlier forecast of 7.8%, although industrial production has been recovering, albeit unevenly.
“The sustained weakness of consumption spending, especially in rural areas as indicated in the slowdown in sales of two-wheelers and tractors, continues to operate as a drag. Corporate sales have contracted. The disappointing earnings performance could have been worse if not for the decline in input costs,” Rajan said.
Low, and even falling, capacity utilisation in several industries, indicative of the slack in the economy, Rajan said.