In its mid-quarter monetary policy review today, the Reserve Bank of India (RBI) reduced banks' cash reserve ratio (CRR) by 25 basis points to 4.50 per cent. However, the key policy repo rate has been kept unchanged at 8 per cent.
"As inflationary tendencies have persisted, the primary focus of monetary policy remains the containment of inflation and anchoring of inflation expectations,” the RBI in its statement said.
What happened in recent past: In April, RBI had reduced policy rate by 50 basis points, hoping to manage inflation alongside supply-side initiatives for addressing the deceleration of investment and growth.
However, these expectations did not materialise and inflation stood stubbornly at 7.5 percent. The government last week announced reforms allowing foreign firms to invest in retail sector, and divestment plans for select PUS along with aviation sector. Not to mention, the Rs 5 increase in diesel prices.
The RBI's move today was a cautious step, C Rangarajan, Chairman of PMEAC, told CNBC TV18.
The central bank has taken into consideration the latest inflation data, which prompted it to keep repo rate unchanged, he said.
However, taking cognisance of the government's efforts to introduce reforms, the RBI has reduced the CRR by 25 bps, which, according to Rangarajan, is likely to be more potent in reducing lending rates. Although, the CRR cut is nominal it is only to address demand pressures, he added.
"We believe this move of RBI is what is required (CRR cut will help contain the interest rates at the current levels) and Repo rate cut will not necessarily have the same transmission effect," said Vivek Mahajan, head of research, Aditya Birla Money, in a press release.
Chanda Kochhar, Managing Director & CEO, ICICI Bank said in a press release, "Given the comfortable liquidity and the recent reduction in deposit rates by banks, interest rates in general could be expected to trend downwards gradually."
What this means for you as a borrower:
Typically, an increase in policy rate means tightening of liquidity which may translate into hardening of interest rates. The 25 basis point cut in CRR is freeing up a total of Rs 17,000 crore for banks. CRR is the amount of money banks have to park with the RBI.
In the last few weeks, starting August have seen several banks cut interest rates on both fixed deposits as well as various retails loans, including home as well as auto loan. Vipul Patel, CEO, Home Loan Advisors, says, “When CRR is decreased, the liquidity increase, which results in decreased cost of funds. Which means, we should see a downward revision in base rate for banks in times to come."
Base rate is a benchmark rate and the minimum rate banks offer their borrowers. While the recent cut in interest rate of various retails loans, benefited only new borrowers, a reduction in base rate will benefit the existing borrowers too. So, when banks bring down base rate in response to the CRR cut, expect the rate on your existing loans to fall.
But, prior to base rate reduction expect more cuts in fixed deposit rates. R.K. Bansal, Executive Director, IDBI Bank, says, "We will take a call on deposit rates first and later take a call on the banks' base rate." Most banks ALCO (Rate setting panel meeting) are expected to be scheduled in weeks to come. Lending rates are expected to fall gradually.
A few week back, Finance Minister, had asked banks CEOs to reduce lending rate on various retail loan, to give a boost to the economy.
What it means for you as an investor:
As an investor, you may see a fall in your FD rates. So it would be better if you lock in your funds now, before the cut begins.
That goes for FDs, but what about bond investors? Recent times have seen a large amount of money flowing into the debt markets. A large number of non convertible debentures (NCDs) have been launched. “Now that interest rates are expected to decrease further, the prices of bonds are expected to increase. As lay investors, as interest rates fall, stay away from bonds, and invest in equity instruments instead, of course, based on your individual asset allocation” said Yeshwant Aangne, a Mumbai based, Certified Financial Planner (CFP).