ECONOMY GETS ANOTHER RATE-CUT STIMULUS

ECONOMY GETS ANOTHER RATE-CUT STIMULUS
The Economic Times, March 5, 2009, Page 1

Repo, Reverse Repo Rates Cut 50 Bps Each

Motioning banks to cut rates further, RBI has clipped reverse repo & repo rates to 3.5% and 5%. But the immediate impact on demand remains to be seen

Our Bureau MUMBAI

AS THE longevity of the slowdown continues to gnaw the economy, Reserve Bank of India (RBI) governor Duvvuri Subbarao is firing on all policy cylinders. After nudging banks to cut rates, Mr Subbarao on Wednesday clipped two key interest rates by 50 basis points each—a move that is intended to signal more rate cuts.

The monetary authority has lowered the reverse repo rate—the rate at which it borrows from banks—as well as the repo rate—the rate at which it lends to banks—to 3.5% and 5%, respectively. The decision will make it less attractive for banks to park money with RBI, pushing them to lend more.

While the move’s impact on the overall demand in the economy could take a little longer, it’s good news for borrowers.

According to HDFC chairman Deepak Parekh, borrowing costs will fall across the board. “We may announce something at the end of the month, effective April 1,” he told ET.

The country’s second-largest lender, ICICI Bank, is also positive on the rate cuts. “RBI has sought to create conditions conducive to consumption and investments, taking into account the global developments and their impact on India—slowdown on growth on one hand and decline in inflation on the other,” said ICICI Bank joint MD and CFO Chanda Kochhar.

The market, however, had to grapple with a somewhat misleading statement during trading hours when Prime Minister’s Economic Advisory Council (PMEAC) chairman Suresh Tendulkar said the central bank may not tweak rates as banks are flush with funds. He felt that a rate cut may not help as banks are overcautious.

According to sections in the bond market, RBI’s decision, though well-intended, was perhaps mistimed. “I am surprised...A rate cut sometime in end-March would have been more helpful. By then, Rs 34,000 crore in borrowing would be over,” said STCI Primary Dealer (a bond house) MD Pradeep Madhav.

Indeed, high government borrowing has prevented interest rates from dropping quickly and caused a fall in bond prices, prompting RBI to announce a Rs 9,000-crore buyback of securities to support prices.

SPUR OF THE MOMENT

Does it matter?
If you are confident of retaining your job, plan for a loan. Interest rates are softening and will come down more in the days to come. However, lower interest on bank deposits could be a bit of a political issue.

Is it too little too late?
Not exactly. Any rate cut has to work its way through the system. Rates can't be lowered dramatically. Home, auto and other loan rates could have come down faster if government borrowing was lower.

What does this mean for banks?
A drop in yields will push up bond valuations a little. But unless it is sustained till March 31, it will not benefit banks and bond houses. Bank shares may move up in a knee-jerk reaction, but fears of bad loans and defaults could spoil the show.

How soon will rates fall?
Advance tax outflows may keep rates high till next week. The drop will be immediate for corporates as banks push loans to increase their loan books at the end of the year. The new financial will see loans for retail borrowers coming down as well.

WHAT'S COULD BE RBI'S

GAME PLAN?
Push banks to lend. Banks will now find that the return on money parked with RBI will not even cover the cost of savings deposits. Unlike the government, RBI is not covered by the pre-poll code of conduct. So, there could be another rate cut before the elections.