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18 Apr 2012

RBI Credit Policy

Citing the upside risk in the inflation and the downside risk in the growth, RBI (Reserve Bank of India ) took a surprising step to reduce the Bank lending rate (Repo rate)  by 50bps i.e from 8.5% to 8%. This is the rate by which RBI allows finance to the commercial banks.

If the bank rate goes up, long-term interest rates also tend to move up, and vice-versa. Thus, it can be said that if bank rate is hiked, in all likelihood, banks will soon hike their own lending rates to ensure that they continue to make profit. Thus the Bank Rate (also called as the Repo Rate) is the tool which is used by the Central bank (RBI) for infusing liquidity into the market. In contrast to Repo rate, there is the “Reverse repo rate” which is the rate of interest at which the central bank borrows funds from other banks for a short duration. It is used by the central bank to absorb liquidity from the economy. When it feels that there is too much money floating in the market, it increases the reverse repo rate, meaning that the central bank will pay a higher rate of interest to the banks for depositing money with it.

The move to cut rates comes in the backdrop of a slowdown in growth which decelerated to 6.1 per cent in the third quarter of last year. The RBI had given guidance in January that it would reverse its tightening cycle. There was a pause for two quarters on key policy rates although there was relief on the liquidity front with 125 basis points CRR cut, done in two stages in January and March. This released Rs 80,000 crore into the system. The RBI also injected about 1.3 lakh crore through open market operations. This is now followed by repo rate cut.

RBI has now played it safe by projecting an inflation target of 6.5 per cent by March 2013. Its GDP projection for this year is 7.3 per cent. It is considered to be a dovish move by RBI, in response to the macro economic report which had a hawkish view of the economy, and had a comprehensive view of all the factors that might influence the monetary policy decisions. Hawkish refers to a negative outlook on inflation, implying that price levels are too high. “Hawkish” is an adjective typically used to describe monetary policy which favors higher interest rates, tighter monetary controls and restrictive credit policy. “Dovish” on the other hand emphasizes on a more accommodative monetary policy.

The marginal standing facility rate, which has a spread of 100 basis points above the repo rate, is now at 9.0 per cent. Banks have been given some relief on the liquidity front. The RBI has decided to raise the borrowing limit of scheduled commercial banks under the marginal standing facility (MSF) from one per cent to two per cent of their net demand and time liabilities.


Siddhesh Sardesai
IW Committee