Cut in Repo and Rerverse Repo Rates

Sending a strong signal to banks to lower lending rates, the Reserve Bank of India on Wednesday cut repo and reverse repo rates by half a percentage point each with immediate effect. Though market has been speculating a rate cut, the mid-week announcement took bankers and marketmen by surprise.
With the latest cut, the repo, the rate at which the RBI lends short-term funds to banks, now stands at 5 per cent and the reverse repo, the rate at which the RBI borrows from banks, at 3.5 per cent.
Banks are expected to cut both lending and deposit rates. Though the central bank had cut its key rates earlier in January, some banks, particularly those in the private sector, were reluctant to reduce their lending rates. This is the second rate cut by the RBI this calendar year.
With inflation rate falling to 3.36 per cent for the week ended February 14, 2009 and GDP growth falling to 5.3 per cent for the third quarter, it was widely expected that the RBI would cut rates
Bankers, however, said reduction in lending rates will depend on their cost of funds.
Mr V. Santhana Raman, Executive Director, Bank of Baroda, said, “With the rate cuts now, the cost of funds could become cheaper and liquidity ample. Even if banks don’t cut rates immediately, in a few days time, they will have to revisit their lending rates. We will evaluate the situation and take a decision shortly.” In the Third Quarter Review of the Monetary Policy, announced in January, the RBI had left key rates unchanged, but had indicated that banks must cut lending and borrowing rates.
The same concern is reflected in today’s announcement. “It is expected that the reduction in the policy interest rates will further encourage banks to provide credit for productive purposes at viable interest rates. The Reserve Bank, on its part, would continue to maintain ample liquidity in the system,” said the RBI.
It has also cautioned banks to monitor their assets and take timely action to prevent defaults.
The average PLR for most public sector banks is now 12.5 per cent.
According to Mr Keki Mistry, Managing Director, HDFC, the RBI move is aimed at creating confidence among banks so that they can lend further.
Asked if HDFC is likely to cut rates, Mr Mistry said, “The cut in the rates will have no direct impact on our cost of funds. When interest rates in the system go down, and our cost of funds comes down, we will pass them on to our customers.”
(Source : Businessline)