Partially reversing measures announced by his predecessor D Subbarao to support the rupee, Rajan brought down the marginal standing facility (MSF) rate by 75 basis points to 9.5% from 10.25%.
The calibrated withdrawal will provide a boost to growth, reduce the financing distortions in the market and reduce the strain on corporate and bank balance sheets, Rajan said, adding that easing the exceptional measures was warranted in the light of the improved external environment and measures taken by the government and the REI to tackle the current account deficit and its funding.
Cumulatively, these two measures will bring down the cost of funds borrowed by banks from the REI by roughly R450 crore, assuming an average liquidity deficit of R1 lakh crore.
Ironically, while the cost of market borrowings may ease marginally, loan rates for retail borrowers may continue to rise with bankers choosing to take their cue from the prevailing tight liquidity conditions as also the RBIs decision to hike the repo rate citing the need to bring down inflation to more tolerable levels and to anchor inflation and inflationary expectations.
Now the busy season has started so there is a huge credit demand and banks are scrambling for deposits. Deposit rates, I think, will go up and accordingly lending rates can also go up, State Bank of India chairman Pratip Chaudhuri said.
The cut in the MSF rate brought down the cost of funds in the commercial paper (CP) and certificate for deposit (CD) markets used by corporates and market to borrow short-term funds by up to 25 basis points, with three-month CP rates slipping from over 11% on Thursday to near 10.5% on Friday and CD rates slipping from near 10% to 9.8%.
Banks can now borrow up to 0.5% of their deposit base from the RBIs liquidity adjustment facility window at 7.5%. However, for any further borrowings from the REI, banks must resort to the MSF window at a higher cost.
Loan demand has already strengthened in recent weeks with non-food credit growing at its fastest pace in over a year at 18.40% year-on-year to R55,11,822 crore for the fortnight ended September 6. Deposit growth, meanwhile, remained anaemic at 13.37% in the fortnight.
SBI raised its base rate by 10 basis points to 9.8% on Thursday along with an increase of 30-100 basis points in deposits across different maturities. Last month, ICICI Bank and Axis Bank raised base rates by 25 bps each to 10% and 10.25%, respectively, while HDFC Bank had raised it by 10 bps to 9.8%.
I expect banks to set rates appropriate to the cost of funds. I hope they will and not look into the future and anticipate some hypothetical move, said Rajan, when asked how he expects banks to react to the RBIs policy.
While the central bank left the cash reserve ratio steady at 4%, it did provide some elbow room to banks by reducing the minimum amount needed to be maintained on a daily basis to 95% from 99%.
The stock markets reacted negatively to the Reserve Bank of Indias decision to hike the repo rate to contain inflation despite the sluggishness in growth. The Sensex closed at 20,263.71, down 383 points or 1.85%, while the Nifty closed lower by 103 points or 1.7% at 6,012.10.
Banks and other interest rate-sensitive stocks were the biggest losers in Friday's trade. Bonds saw a steep sell-off as well with the 10-year benchmark yield spiking to 8.56% compared with 8.19% on Thursday. The rupee weakened by 51 paise to close at 62.28, even though the RBI confirmed that an inflow of $1.4 billion had already been seen following the swap facilities offered to banks to bring in funds raised through overseas borrowings and foreign currency non-resident deposits.
"Events over the last few weeks have had an impact on what we think our forecast for inflation is likely to be. Take the rupee depreciation or the temporary higher price of oil. These are all factors that could add to inflation along with suppressed inflation being let in, explained Rajan.
While the governor stressed that he remains neutral about the next move on the repo rate and that it would be dependent on evolving growth-inflation dynamics, market players are not ruling out another round of rate hikes from the RBI should inflation surprise to the upside.
Over time, even as the RBI lowers the MSF rate, it may further hike the repo rate given the greater focus on CPI inflation, Sonal Varma, economist at Nomura, said in a note.