RBI cuts repo rate and CRR, sets stage for lower interest rates

The Reserve Bank of India (RBI) cut rates for the first time in nine months Tuesday, creating scope for banks to lower the cost of loans for a range of customers from automobile makers to automobile buyers.

The 25 basis point cut in the repo rate for the first time since April 2012 was based on RBI's perception that for the economy, growth, rather than inflation, was the bigger worry. In its third quarter review of monetary policy, the central bank has lowered the growth projection of the economy for this fiscal to 5.5 per cent, and also reduced the year-end inflation estimate to 6.8 per cent.

RBI Governor D Subbarao said the 25 bps cut in repo rate and cash reserve ratio would spur investments, "keep medium term inflation moderate and improve liquidity conditons to support credit flow".

Repo is the rate at which banks buy money from the RBI; cash reserve ratio (CRR) is the portion of deposits that banks must park with the RBI. RBI has now become the first Asian central bank to lower lending rates this calendar year.

The governor expressed optimism that banks would pass on the benefit to the customers. By evening, the public sector IDBI Bank had become the first bank to reduce lending rates by 25 bps. Pratip Chaudhuri, chairman of the country's largest bank, State Bank of India, said he "will pass on (the benefit of rate cut) to our borrowers without compromising on the net interest margin".

The finance ministry has long been urging RBI to cut rates as growth momentum slipped in the economy, but the bank had held out, citing strong inflation trends. The focus now shifts to the general budget due on February 28 for indications on how effectively the government is able to keep fiscal deficit in check, in both this fiscal and the next.

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