RBI signals lower interest regime; slashes CRR, bank rate - Views on News from Equitymaster

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  • Apr 1, 2000 - RBI signals lower interest regime; slashes CRR, bank rate

RBI signals lower interest regime; slashes CRR, bank rate

Apr 1, 2000

The Reserve Bank of India (RBI) has announced a 1% cut in both the Cash Reserve Ratio (CRR) and the Bank Rate (BR). The CRR and BR now stand at 8% and 7% respectively. The move comes ahead of the announcement that the RBI will be presenting the Credit and Monetary Policy for the slack season on the 27th of April 2000. The RBIís decision to lower rates and increase the availability of credit will be welcomed by the industrial community. This is mainly due to the increasing demand for credit as a result of a pick up in economic activity. Lower rates would imply lower borrowing costs and hence, healthier profit margins (assuming of course that other factors remain the same).

The banks on the other hand would face a mixed scenario. On the one hand a decline in the CRR requirements would free up more funds (which earn marginal interest) to deploy as credit (at market related rates of interest). The cut in lending rates (it is likely that banks will announce a cut in rates) however could lead to a temporary decline in spreads as the cost of the banks deposit rates would remain relatively unchanged (atleast for sometime) i.e. only fresh deposits would involve lower costs. This would also depend on the stickiness of deposit costs and the cost at which funds have been deployed. For banks that have a large quantum of funds deployed at fixed rates of interest, the effect would be limited.

The RBIís decision is likely to give a boost to stock market sentiment, which has been languishing of late. This is mainly due to two reasons. First, lower borrowing costs would imply higher earnings for companies (and also lower price to earnings multiples). And second, the opportunity cost of investors would reduce, thus reducing rate of return expected by them. This would have the effect of improving the investment value of stocks vis a vis other avenues of investment, thus driving more money in to the markets.

The RBIís decision to cut the CRR and BR is a welcome step. However, the quantum of benefits that actually flow to the investors and corporate would largely depend on the size of government borrowing. Given that the fiscal deficit is in excess of Rs 1,100 bn, the low interest rate regime may not last that long, unless of course the government mends its ways.

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