India’s central bank cuts key rates, warns of ‘painful adjustment’ (Roundup)

December 6th, 2008 - 4:31 pm ICT by IANS  

Mumbai, Dec 6 (IANS) Reserve Bank of India (RBI) Governor Duvvuri Subbarao Saturday warned of a period of “painful adjustment” for the country’s economy as he cut key rates to lower the cost of funds for commercial banks and help them reduce their interest rates for the corporate sector.Monetary measures to help exporters, small and medium enterprises, the housing industry and the corporate sector in general formed the bulk of the measures in the package for growth stimulus unveiled by the governor, that evoked positive response, amid caution, from commercial banks and India Inc.

The repurchase rate, or the repo rate, is being cut by 100 basis points, while the reverse repo rate will be reduced by a similar amount, Subbarao announced, adding the new rates would take effect Monday.

The repo rate, currently at 7.5 percent, is the interest charged by the RBI on borrowings by the commercial banks. A reduction in the same makes the cost of borrowings cheaper for commercial banks.

The reverse repo rate, on the other hand, is the rate at which the central bank borrows money from commercial banks. A lowering of this rate, presently at six percent, makes it less lucrative for banks to park funds with the central bank.

There were no changes in cash reserve ratio (CRR) and statutory liquidity ratio (SLR).

The CRR - the minimum liquid funds banks have to keep against deposits - is now at 5.5 percent. The statutory liquidity ratio (SLR) - the funds such institutions have to hold in government bonds - is currently pegged at 24 percent.

“The cumulative impact of the measures in today’s package, together with earlier measures, should be to step up demand and arrest the growth moderation,” the RBI governor told a press conference here to unveil the growth stimulus package.

But he also had a note of warning and concern over the developments globally and their impact on the Indian economy, as he felt that the confidence level on the international financial was low and credit lines remained clogged.

“A period of painful adjustment is inevitable.”

He said it was difficult to precisely anticipate every development in the global financial system, Given the uncertain outlook, but assured timely steps from the central bank to help tide over the crisis, that has lowered India’s growth.

“Once the crisis is behind us and calm and confidence are restored in the global markets, economic activity in India will recover sharply.”

The central bank package also included a refinance facility for Small Industries Development Bank of India (Sidbi) worth Rs.7,000 crore (Rs.70 billion/$1.4 billion) and for National Housing Bank (NHB) worth Rs.4,000 crore (Rs.40 billion/$800 million).

Subbarao also said that housing loans under Rs.2 million will be classified under priority sector, exceptional treatment would be extended to banks’ real estate exposures and their financial restructuring will be eligible for exceptional regulatory treatment.

The central bank governor said while the measures Saturday should step up demand and arrest the growth moderation, the steps taken since September had released net liquidity since worth Rs.300,000 crore (Rs.3,000 billion/$60 billion).

The measures came after the government Friday permitted state-run oil retailers to cut prices of gasoline by Rs.5 per litre and diesel by Rs.2 a litre for the first time since February last year.

“The fuel price cut will lower headline inflation by 40-45 basis points,” the central bank governor said.

Bankers, however, reacted cautiously to the central bank’s announcement, as did the corporate sector, which wanted the central bank to reduce the CRR and SLR to infuse more liquidity into the system.

“This is certainly a very strong signal. But as I have always said just repo rate cut do not ensure there is enough liquidity in market,” said Chanda Kochchar, joint managing director of ICICI bank, India’s largest in the private sector.

“There are many other factors to be considered. It just require some cooling off time to go for interest rate cut on credits,” she added.

“Even while this is a very positive measure specifically for the hosing sector, it depends on how banks take it. I feel banks will lower interest rate between 50 to 100 basis points,” added Keki Mistry, managing director of Housing Development Finance Corp.

“A good start in the correct direction,” said Amit Mitra, secretary general of the Federation of Indian Chambers of Commerce and Industry (ficci), reacting to the rate cuts.

“But the central bank could have gone a step further by cutting the CRR and SLR rates to send a stronger signal of liquidity support to corporates,” he said - an opinion shared by the Associated Chambers of Commerce and Industry (Assocham).

The two chambers hoped commercial banks would cut their lending rates after the steps taken by the Reserve Bank, adding that the lending institutions had thus far been sluggish and have not cut the cost of borrowing for India Inc in a substantive manner.

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