RBI signals another rate cut; slashes repo, CRR

Signaling a further drop in interest rates, the Reserve Bank of India has announced the reduction of the repo rate under the liquidity adjustment facility (LAF) by 100 basis points from 6.5 per cent to 5.5 per cent with immediate effect.

The reverse repo rate under the LAF will also be slashed by 100 basis points from 5.0 per cent to 4.0 per cent with immediate effect.

The apex bank also announced that the cash reserve ratio (CRR) of scheduled banks will reduced by 50 basis points from 5.5 per cent to 5.0 per cent from the fortnight beginning January 17, 2009.

The RBI announcement said that the reduction in the CRR will inject additional liquidity of around Rs. 20,000 crore to the financial system.

It is expected that the reduction in the policy interest rates and the CRR will further enable banks to provide credit for productive purposes at appropriate interest rates. The Reserve Bank on its part would continue to maintain a comfortable liquidity position in the system.

Even as some public sector and private sector banks have cut lending rates in response to the Reserve Bank’s monetary policy stance, concerns over rising credit risk together with the slowing of economic activity appear to have moderated credit growth.

The Reserve Bank continues to urge banks to monitor their loan portfolio and take early action, including debt restructuring where warranted, to prevent the rise of bad assets down the road and safeguard the gains of the last several years in improving asset quality. At the same time, banks should price risk appropriately and ensure that quality enterprises continue to get funding.

The Reserve Bank appreciates that risk management is difficult even in normal circumstances; it is even more difficult in an environment of uncertainty and downturn.

The fundamentals of the indian economy continue to be strong. Once the crisis is behind us, and calm and confidence are restored in the global markets, economic activity in India would recover sharply. But a period of painful adjustment is inevitable, the Bank pointed out.