Repo rate cuts: the next big decision for RBI

Business

oi-Sunil

By Sunil Fernandes

Published: Saturday, March 10, 2012, 11:44 [IST]

The RBI startled the banking sector by cutting CRR rates, just six days before the monetary policy review. Though the move has been welcomed by bankers, the craving has always been for a repo rate cut, as it tends to improve the fundamentals of the banking sector and the economy enormously.

The RBI was widely expected to cut the cash reserve ratio (CRR) in its monetary policy review on March 15, though the decision came a few days in advance and caught the markets by surprise. Of course, the quantum of 75 bps was largely unexpected and startled the markets positively, which were expecting a 50 bps cut.

Of course, the cut in CRR is most welcome, and helps to ease liquidity. But the big question now is: What will the RBI do on March 15? Will it cut the repo rate?

The cut in repo rate depends on many variables. The prime being inflation. As inflation comes down the RBI signals lowering of interest rates by cutting the repo rates. Repo rates are the rates at which the RBI lends to banks. If it lends at lower rates, it tends to reduce the cost of funds for banks and hence helps in lowering interest rates in the economy. Now lower interest rates in the economy propels investments and facilitates an upsurge in economic activity, which invariably leads to better growth rates.

However, when inflation is high, because interest rates are low, the RBI is forced to hike the repo rates to reduce inflation, which in turn increases interest rates and lowers economic growth.

Currently, growth has reduced and so has interest rates, which might induce the RBI to cut repo rates. However, it has once again to keep in mind that crude is rising and rising crude exerts inflationary pressure in India. The inclination has always been to give inflation a priority over growth.

Hence, if one were to stick one's neck out and predict, then, one would have to believe that a repo rate cut may not happen on March 15, as the RBI would like to see inflation lower on a sustainable basis. RBI Governor D Subbarao faces a strange predicament on how to balance growth and inflation, while he takes a decision of repo rate cuts.

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