RBI reduces rate by 0.5 per cent for stronger growth; SBI follows suit

Mumbai: RBI governor Raghuram Rajan on Tuesday took everyone by surprise by announcing a cut of a hefty 50 basis points (half a per cent) in the repo rate (rates at which banks borrow from the RBI). While it gave a big boost to the markets and corporate India, it will hit small savers hard as the RBI decision forced the government to review interest rates on small saving schemes.

Explaining the factors behind the rate cut, Dr Rajan said the environment was right for a front-loaded rate cut as global growth and trade continued to slow down, affecting domestic growth and exports; while new investment was not forthcoming from the risk-averse private sector, bank lending was constrained by stretched assets.

Dr Rajan’s surprise move catapulted the stock markets, which were in red due to global cues, into the green. There was all-round jubilation, from the stock markets to economists, banks and analysts. Some called him Santa Claus, others said Dr Rajan brought Diwali forward and yet others said it was Diwali, Christmas and New Year rolled into one.

A relaxed Rajan, however, said he was neither a Santa Claus nor was he giving a “Diwali bonus”. “I don’t know what you want to call me... Santa Claus... you want to call me a hawk or a dove. I don’t know. I don’t go by this. My name is Raghuram Rajan and I do what I do,” said Dr Rajan, who was often referred to a rock star central banker.

On it being a Diwali bonanza, he said, “We wanted to be sure that the words sustainable and growth go together. Both are important, and that’s why we used what room we had. But I don’t think we were excessively aggressive. We were not throwing out a Diwali bonus.” He said the “economy has legacy problems and there are no silver bullets”.

Home loan borrowers have a lot to cheer about in the policy. While the rate cut will lead to lower lending rate, the RBI’s decision to reduce the minimum risk weightage applicable to individual housing loans will release additional funds for housing loans. Meanwhile, in a bad news for small savers, the Union finance ministry indicated Tuesday it may lower interest rates on small savings schemes (mostly those that are offered by post offices and PPF) to nudge banks to bring down their lending rates.

“It has also been decided the government will undertake a review of small savings interest rates,” economic affairs secretary Shaktikanta Das said on Tuesday. While the RBI has cut interest rates by 1.25 per cent this year, the banks have been reluctant to fully pass on these cuts to consumers by lowering interest rates on loans to the same extent.

Of the 75 basis point cut in Reserve Bank of India rates (before Tuesday’s action), the median base lending rates of banks had fallen by only 30 basis points.
Banks argue that their deposit rates are high as small savings schemes offer higher returns. Banks told the government that until their deposit rates don’t come down, they can’t fully pass on the benefit of lower repo rates.