The Hindu Business Line : Relief for borrowers post rate cuts

The repo rate, the rate at which banks borrow from the RBI, has often been used as the signalling rate for short-term changes in interest rates. After a series of hikes in the repo rate, the RBI cut it by 100 basis points (bps) to 8 per cent on October 20, and further to 7.5 per cent on November 3.

The latter was done in conjunction with a cut in the cash reserve ratio and the statutory liquidity ratio by 100 bps. Apart from signalling a reversal in the interest rate direction for the first time since 2004, this move was intended to inject liquidity into the cash-starved financial system.

A rate reversal

The repo rate, which was 6.5 per cent in January 2006, has seen a series of increases since then. However, the initial increases were made after significant gaps. It was 7.75 per cent from March 31, 2007 till June 12, 2008, when it was hiked to 8 per cent.

Successive hikes took the repo to 9 per cent by end-July 2008. The rate was hiked in order to anchor inflationary expectations. The spike in commodity prices, with oil prices peaking at $147 a barrel, set off an inflation spiral, and the RBI adopted a tight monetary policy to be in sync with the market conditions at that point of time.

Aiding Liquidity

However, as the sub-prime mortgage crisis resulted in a credit squeeze in various economies across the world, central banks responded with rate cuts. The RBI too resorted to rate cuts to ease the credit crunch and inject liquidity into the system. The tightness in the credit market was evident from the fact that call money rates went beyond 20 per cent and have since fallen to 5-6 per cent after the rate cut.

Following the recent cuts in repo rates, many public sector banks announced plans to cut their lending rates. Private banks are expected to cut their lending and deposit rates over the next 15 days. State Bank of India, other public sector banks and Citibank have announced a reduction in their benchmark prime lending rates (BPLRs). A reduction in deposit rates is expected to follow soon.

With reduced lending and deposit rates, banks may expect a reduction in the cost of funding and easing pressure on net interest margins.

Lower interest rates may also signal some relief for corporate and retail borrowers from the recent escalation in borrowing costs. However, while policy rates signal a downtrend, the key question is whether banks will prefer to lend to sectors with a high-risk profile.

C. N. M. LAVANYA

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