RBI cuts rates to ease cash squeeze, support growth

The Reserve Bank of India (RBI) on Saturday unexpectedly cut its main short-term lending rate for the second time in as many weeks to ease a growing cash squeeze, spur faltering economic growth and fend off damage from the global financial crisis.

Analysts said the surprise RBI move, coming just a week after it left rates unchanged at a policy review, showed its concern that strains on Asia's third-largest economy were quickly becoming more severe.

"These actions were necessary (and had) to be taken on the liquidity front. And with call rates above 20 percent the situation was getting worse," said Vikas Agarwal, strategist at JP Morgan.

"The only question at this point of time which arises is why this was not taken at the time of the policy review last week and the only explanation is they did not anticipate the extent of the liquidity crunch," Agarwal added.

Policymakers around the world have slashed interest rates in recent weeks and injected huge amounts into their banking systems to try to combat the spillover effects of the global financial crisis, which is causing credit markets to freeze up and threatens to plunge the world economy into recession.

Analysts said the surprise move meant concerns over growth and cash tightness overrode inflationary issues but bankers said they would adopt a wait-and-see stance before deciding on lowering their lending and deposit rates.

V. Vaidyanathan, executive director at ICICI Bank the country's second biggest lender told CNBC-TV 18 the move was a welcome step to tide over the cash crunch but it won't rush into interest rate cuts immediately.

The RBI cut the repo rate or its main short-term lending rate by 50 basis points to 7.5 percent and banks' cash reserve requirements by 100 basis points to 5.5 percent.

SLOWING GROWTH

It also cut banks' bond reserve requirements by 1 percentage point to 24 percent of their deposits with effect from November 8, 2008, the central bank said in a notification posted on its website. www.rbi.org.in.

"The global financial turmoil has had knock-on effects on our financial markets; this has reinforced the importance of focusing on preserving financial stability," the central bank said.

The cut in its repo rate will take effect from Nov. 3.

The cut in banks' cash reserve requirements will take effect in two steps -- one from the fortnight beginning Oct 25 and the second from Nov 8 and will release 400 billion rupees ($81 billion) into the banking system.

Piyush Wadhwa, senior vice president, ICICI Securities said the 10-year bond yield could spike up by 5-10 basis points on Monday as result of the central bank move asking lenders to keep less of their deposits in federal debt but yields may ease in the medium term.

On Friday, the 10-year bond yield ended down 1 basis point at 7.50 percent.

India's economy has grown at or above 9 percent for the past three fiscal years, but is expected to grow by less than 8 percent this year as the global slowdown reduces exports. Industrial output grew at an annual rate of just 1.3 percent in August.

Rajeev Malik, economist at Macquarie Securities said the firm was cutting the country's growth estimates for the current year ending in March to 7.2 percent from the previous 7.5 percent due to the global market turmoil.

Overnight cash rates soared to a three-week high of 21 percent on Friday after outflows towards treasury bills drained cash from the system and banks scrambled to arrange funds for a the bond auction which took place earlier in the day.

The RBI move to cut rates on Saturday follows a 100 basis point cut in its main short-term lending rate early last week ahead of its scheduled review on Oct 24.

Source: - Reuters

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