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Rajan cuts key rate by 25 bps, eases liquidity

Rajan cuts key rate by 25 bps, eases liquidity
Given weak private investment in the face of low capacity utilisation, a reduction in the policy rate by 0.25 per cent will help strengthen growth, RBI Governor Raghuram Rajan said in the first bi-monthly monetary policy review for the 2016-17 fiscal, which began on April 1. Accordingly, the repo rate, at which RBI lends to the financial system, has come down to 6.5 per cent.

The cut was broadly in line with expectations. However, the stock market reacted negatively and the BSE index, Sensex, was down nearly 300 points. Rajan also took a host of measures on the liquidity front, starting with the narrowing of the policy rate corridor to 0.50 per cent from the earlier 1 percentage point, which resulted in the reverse repo rate - at which banks can park excess funds with the RBI - being reset at 6 per cent.

The policy said the average overnight borrowings by banks have increased to Rs 1,935 billion in march from Rs 1,345 billion in January.

Stating that the inflation objectives are closer to being realised and price-rise will hover around the 5 per cent mark for the remainder of the fiscal, Rajan reaffirmed that the monetary policy will continue to remain accommodative to address the growth concerns.

RBI also retained its GDP growth forecast at 7.6 per cent, on the assumption of a normal monsoon and a boost to consumption through the implementation of the Seventh Pay panel recommendations.

The central bank said it expects the implementation to hurt inflation by 1-1.5 per cent over a two year period, but added that the shock will not be as strong as that felt during the implementation of the sixth pay panel suggestions.

Rajan welcomed the government move to amend the RBI Act to create a monetary policy committee, saying it will further strengthen the policy’s credibility.

He also welcomed the government’s adherence to the path of fiscal consolidation, calling it as a commendable commitment this will support the disinflation process going forward.

The Reserve Bank reiterated the need for a better translation of its policy actions into the lending rates by banks, adding that measures like reduction in the small savings rates, refinements in the liquidity management framework announced in the policy and the introduction of the marginal cost of lending based lending rates will help in this regard.

On the regulatory side, RBI said it is mulling a regime where large borrowers (which account for a bulk of the NPAs) shall be mandated to go to the market for a part of their funding rather than relying on banks completely.

RBI also proposed to redefine bank branches and permissible methods of outreach.

It will also issue a discussion paper to go ahead on the differentiated banking and look into the introduction of custodian banks and wholesale banks, the policy document said.

Home, auto and other loans are set to become cheaper with the Central banker reducing the short-term lending rate by 0.25 per cent to over 5-year low of 6.5 per cent, taking the total cut to 1.5 per cent since January last year. “Borrowing is cheaper...and will continue to do so,” the Governor said, adding that the introduction of marginal cost of funds-based lending rate (MCLR) system will improve monetary policy transmission.
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