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Editorial | April 2012

Policy reversal? May be, may be not!

 The Reserve Bank of India’s (RBI) decision to cut interest rate by 50 basis points (bps) has been welcomed by banks as well as borrowers, and understandably so.The rate cut comes after a long gap of three years, during which period the RBI had hiked the repo rate as many as 13 times consecutively. So the announcement of a higher-than-expected 50 bps rate cut would undoubtedly gladden the hearts of many a retail borrower who were reeling under the high interest burden on their home loans as also the corporate borrowers whose interest outgo on project loans was hurting their cash flows and profitability.

But does the 50 bps rate cut signal apex bank’s move towards cheap money policy? It's too early to draw such an inference, and this has been hinted by the RBI governor D Subbarao himself when he said that the “upside risks to inflation persist which inherently limit the space for further reduction in policy rates”.So, one will have to watch how the inflation pans out in the next few months to ascertain the direction in which the interest rate curve will trend.

In view of this, the private commercial banks were not in a hurry to cut their lending rates and would have preferred to adopt a wait and watch approach.But with the public sector banks (PSBs) falling in line with the Union finance secretary’s reported diktat to cut their lending rates, the peer pressure exerted by the PSBs' rate cut may have prompted the private sector banks to follow suit with matching rate cuts.

The RBI decision to cut the repo rate has been influenced as much by the encouraging inflation numbers as by the discouraging growth numbers.The headline (wholesale price index) inflation has moderated from close to 10 percent in Sept. ’11 to 6.89 percent by March ’12.However, the GDP growth is expected to have decelerated sharply from 8.4 percent in 2009-10 & 2010-11 to 6.9 percent in 2011-12.The interest rate cut is aimed at boosting investments and economic growth.The RBI has also cut CRR by 125 bps in the last two months (Feb & March) to place more funds in the hands of banks and boost liquidity in the system.However, the increased liquidity carries the inherent risk of fuelling inflation, hence, despite the seemingly aggressive repo rate cut, the RBI is expected to tread cautiously on the interest rate front in the next few months.

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