RBI cuts rates, prods banks to help growth

The Reserve Bank of India cut its key lending rate for the sixth time in seven months on Tuesday and pushed commercial banks to follow suit to bolster growth which has taken a bigger-than expected hit from the global downturn.
Analysts said the size of the 25 basis point cut -- the smallest since the Reserve Bank of India began slashing rates last October -- signalled it may be near the end of its cutting cycle, though there was still some way to go before rates bottomed out.
"We don't see it as the end to easing cycle, but the RBI will switch to more gradual cuts and a wait-and-watch policy," said economist Deepali Bhargava at ING Vysya Bank in Mumbai.
"Sectoral credit numbers released yesterday have revealed some pick-up in earlier credit-starved sectors, which is a positive sign."
In its annual policy statement, the central bank said it expected growth to falter sharply for the second year running after expanding at a blistering pace of 9 percent or more in the previous three fiscal years.
Growth was seen slowing to 6 percent in 2009/10, the weakest in seven years, from a downwardly revised estimate of 6.5-6.7 percent for the 2008/09 fiscal year that ended on March 31.
"Any upturn in the growth momentum is unlikely in view of the projected contraction in global demand in 2009/10, particularly the decline in trade," the central bank said.
The RBI also said the government's planned heavy borrowing in 2009/10 was working against its efforts to maintain a low interest rate environment.
Nonetheless, it again called on commercial banks, which have grown risk averse in the face of the slowdown, to follow its lead in cutting rates to boost the economy.
The central bank has now cut its main lending rate by 425 basis points since October, when it and the government stepped up efforts to counter fallout from the global financial crisis after the collapse of Lehman Brothers.
But prime lending rates of five major commercial banks in India have fallen by less than 200 basis points in the same period, limiting the impact of the RBI's moves.
Economic Affairs Secretary Ashok Chawla said the rate cuts would encourage commercial banks to lower their lending rates.
"This is another reiteration of the signal from the RBI to banks and the credit market. There is scope for softening of interest rates," Chawla said.
Analysts said the rate cut will force banks to reduce their lending rates by 50-100 basis points in coming weeks, but it is unlikely to happen immediately as banks have raised funds via high-cost deposits earlier. A government-mandated small savings tax-free rate of 8 percent also acts as a huge deterrent.
Central banks around the world have been slashing interest rates for months in a bid to revive economic growth, with the U.S. Federal Reserve, the Bank of England and the Bank of Japan cutting rates to near zero. On Tuesday the Swedish central bank cut its key policy rate to a record low.
HISTORICAL LOW
The RBI cut its lending rate to 4.75 percent from 5.0 percent and its reverse repo rate , at which it absorbs surplus cash from the system, to 3.25 percent from 3.5 percent, taking both rates to the lowest since they were introduced in 2000.
A Reuters poll last week showed analysts were evenly split over whether the central bank would cut its key lending rate.
The cash reserve ratio , the amount of funds banks have to keep on deposit with it, was unchanged at 5.0 percent.
The 10-year bond yield fell to 6.19 percent after the policy announcement from the previous close of 6.39 percent, edging up to 6.22 percent in afternoon trade.
The rupee recovered morning losses and by mid-afternoon was around 50.30 per dollar, a touch stronger than the previous close of 50.33/34.
Although the RBI said it would maintain ample liquidity in the banking system, it said a major challenge was to manage large government borrowings without disruptions to financial markets.
The government plans record gross issuance of 3.62 trillion rupees of debt in 2009/10, and the RBI said it would use a mix of monetary and debt management tools to ensure its smooth implementation.
The government's borrowing swelled to more than double its initial estimate in 2008/09, partly reflecting spending plans in the latter part of the year to stimulate the economy, leading to a flood of bond supplies since February.
(For full coverage on RBI Annual Policy Review click http://in.reuters.com/news/globalcoverage/policyreview)