In a move that could bring further relief to the home, auto and corporate borrowers, the Reserve Bank today cut short-term lending (repo) and borrowing (reverse repo) rates by 25 basis points.
In its annual credit policy for 2009-10, the RBI reduced the repo rate to 4.75 per cent and reverse repo to 3.25 per cent with immediate effect, while retaining other key rates like the cash reserve ratio, the percentage of deposits that banks keep with the central bank.
In view of the ongoing global economic slowdown, the central bank has pegged the economic growth rate forecast for the current fiscal to 6 per cent, against 6.5-6.7 per cent estimated for 2008-09.
"Any upturn in growth momentum is unlikely in view of the projected contraction in global demand during 2009, particularly decline in trade," RBI Governor D Subbarao said in the policy, adding private investment demand was expected to remain subdued.
"The policy instance of the RBI indicates further softening of interest rates," Oriental Bank of Commerce (OBC) Executive Director S C Sinha said.
The good news, however, is on inflation, which is projected to remain at around 3 per cent in the medium term and 4 per cent by the end of March 2010.
The RBI said that the sharp decline in crude oil prices, metals, foodgrains, cotton and cement has influenced inflationary expectations in most parts of the world including India.
"This (declining prices) is also reflected in the domestic Wholesale Price Index (WPI) inflation reaching close to zero," the RBI said.
Noting that inflation is likely to be in negative territory in the early part of 2009-10, the RBI said "expected negative inflation has only statistical significance and is not a reflection of demand contraction as is the case with advanced economies ... And may not persist beyond the middle of 2009-10".
The RBI further said that negative inflation "should not be interpreted as deflation for policy purposes".
As far as reduction in key rates is concerned, it is the sixth time that the RBI cut the repo rate and the fourth time the reverse repo rate since the collapse of America's investment banker Lehman Brothers in mid September 2008.
The central bank has reduced the repo rate by 4.25 percentage points and the reverse repo rate by 2.75 percentage points since then.
Even as the RBI retained the CRR this time, it has injected close to Rs 4,00,000 crore into the system after Lehman Brothers was declared bankrupt.
Even as the RBI has cut lending rates, it had earlier complained that banks are not following suit.
Around 13 public sector banks have cut lending rates by 25-50 basis points from this fiscal, while major private sector banks refrained from doing so.
Economic Affairs Secretary Ashok Chawla is expecting banks to cut lending rates in response to the RBI's move.
"The Reserve Bank has been monitoring the economic situation ... This (RBI's move) is reiteration of signals from the RBI to banks and credit markets," he said.
Meanwhile, the RBI has put on hold a review of policies governing foreign banks, which was earlier slated for this fiscal, in view of the global financial turmoil.
"... [T]he proposed review will be taken up after due consultation with the stake holders once there is greater clarity regarding the global financial system," the RBI said.
On the issue of compensation of CEOs, the RBI said it would recommend implementing "sound procedures/principles and principles developed by Financial Stability Board for financial institutions".
In India, it added "while devising the total renumeration package of CEOs and wholetime directors, boards of private banks are required to ensure that the total package is reasonable in the light of industry norms including size of business in the country".
In its elaborate response on recommendations of the G-20 working group on enhancing regulations, transparencies, the RBI said it will continue to incorporate international best practices for dealing with the problems of tax havens.
In addition, it said it will work with SEBI for better regulation of credit rating agencies.
With the economy growing at a slackening 5.3 per cent in the third quarter of 2008-09, the Reserve Bank cut the projection for GDP growth to 6.5-6.75 per cent from the earlier 7 per cent. It said indicators suggest that growth will moderate more than what had been expected earlier.
Official advance estimates have pegged economic growth to be 7.1 per cent in 2008-09.
The RBI said, "After clocking annual growth of 8.9 per cent on average over the last five years (2003-08), India was headed for a cyclical downturn in 2008-09. But the growth moderation has been much sharper because of the negative impact of the (global) crisis."
Recent data show that demand for bank credit is slackening despite comfortable liquidity in the system.
Dampened demand has dented corporate margins, while the uncertainty over the crisis has affected business confidence.
However, there are several comforting factors -- robust financial markets, comfortable forex reserves, low inflation and robust rural demand -- which have helped India weather the crisis.