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Impact of RBI Repo Rate Cut

March 5, 2009

RBI has reduced the Repo and Reverse repo rate under LAF window by 50 bps each to 5.0% and 3.5%, respectively with immediate effect.

The cut in policy rates by 50 bps each is likely to signal the banks to reduce their lending rates. The reverse repo rate 3.5% would make it less attractive for banks to park money with the RBI.

Now question arises – Can we expect rates to come down dramatically?
We don’t think so! The reduction in lending rate has to be accompanied by the reduction in deposit rates. The deposit rates are less likely to come down unless yields on Gsec would also come down from here-on. However, higher government borrowing program is increasing the supply of government paper and thus pushing the yield higher (i.e. prices of bond going lower). In the environment where other avenues like small saving schemes and PPF are offering higher rate, it would be difficult for the banks to reduce the deposit rates.

The banks have also become risk-averse and are going slow on lending to mid-size corporate on fear of defaults and increasing bad loans. This has made the corporates raise money by means of deposit where rates are way too higher compared to Government backed security / instrument yields.

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