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RBI announces Further Monetary Stimulus: Cuts Repo Rates by 50 bps

March 4, 2009: On a review of the current global and domestic macroeconomic situation, the Reserve Bank has decided to take the following further measures:

Repo Rate

• To reduce the repo rate under the liquidity adjustment facility (LAF) by 50 basis points from 5.5 per cent to 5.0 per cent with immediate effect.

Reverse Repo Rate

• To reduce the reverse repo rate under the LAF by 50 basis points from 4.0 per cent to 3.5 per cent with immediate effect.

It is expected that the reduction in the policy interest rates will further encourage banks to provide credit for productive purposes at viable interest rates. The Reserve Bank on its part would continue to maintain ample liquidity in the system.

Background to announcement of present monetary stimulus by RBI :

Since the release of the Reserve Bank's Third Quarter Review on January 27, 2009, the global financial and economic conditions have further deteriorated as revealed by the latest available information. The US real GDP contracted sharply at an annualised rate of 6.2 per cent in the fourth quarter of 2008 and the unemployment rate in the US has moved up to 7.6 per cent. The real GDP in the euro area also declined by 1.5 per cent in the fourth quarter of 2008. Reflecting deteriorating global demand, Japanese exports fell by 45.7 per cent (y-o-y) in January 2009. The Japanese economy also contracted sharply by 3.3 per cent in the fourth quarter of 2008. The fourth quarter real GDP numbers of several advanced economies have turned out to be worse than expected. The uncertainty, therefore, on global recovery has increased.

As a response, the governments all over the world continue to unveil expansionary fiscal policies. Central banks have also taken several measures to stimulate demand and moderate the impact of the global downturn and credit crunch on their economies. The US Fed and the Bank of Japan have increased quantitative and credit easing measures. The UK further reduced its policy rate by 50 basis points to 1.0 per cent. Among emerging market economies (EMEs), Korea, Indonesia, Thailand, Chile and Mexico reduced their policy rates.

India’s financial sector continues to be resilient in the face of global financial turmoil. Our financial markets continue to function in an orderly manner. India’s growth trajectory has, however, been impacted both by the financial crisis and the follow-on of global economic downturn. This impact has turned out to be deeper and wider than anticipated earlier. Concurrently, because of global developments coupled with supply and demand management measures at home, WPI inflation is on the decline along the expectations of the Third Quarter Review.

Reflecting these developments, the aim of various measures initiated by the Reserve Bank since mid-September 2008 has been to augment domestic and forex liquidity and to ensure that credit continues to flow to productive sectors of the economy. Notably, since mid-September 2008, the Reserve Bank has reduced the repo rate under the liquidity adjustment facility (LAF) from 9.0 per cent to 5.5 per cent, reduced the reverse repo rate under the LAF from 6.0 per cent to 4.0 per cent, the cash reserve ratio (CRR) from 9.0 per cent to 5.0 per cent of net demand and time liabilities (NDTL) and the statutory liquidity ratio (SLR) from 25.0 per cent to 24.0 per cent of NDTL.

The cumulative amount of actual or potential primary liquidity made available to the financial system through various measures initiated by the Reserve Bank is over Rs. 3,88,000 crore. Besides, the reduction in SLR by one percentage point of NDTL has made available liquid funds of the order of Rs.40,000 crore for the purpose of credit expansion. This sizeable easing has ensured a comfortable liquidity position. The overnight money market rate has remained near or below the lower bound of the LAF corridor since November 3, 2008.

Consequent to the announcement of fiscal stimulus packages, the market borrowing programme of the Central Government for 2008-09 was raised to Rs.3,42,769 crore (gross) and Rs.2,66,539 crore (net) as against the budgeted amount of Rs.1,76,453 crore (gross) and Rs.99,000 crore (net). Against this enhanced borrowing programme, market borrowing of the Central Government has been Rs.2,66,276 crore (gross) and Rs.1,92,315 crore (net) up to March 3, 2009. In terms of the amendment to the Memorandum of Understanding on Market Stabilisation Scheme (MSS) on February 26, 2009, an amount of Rs. 45,000 crore will be transferred in installments from the MSS cash account to the normal cash account of the Government of India by March 31, 2009. An equivalent amount of government securities issued under the MSS would now form part of the normal market borrowing of the Government of India. This arrangement should provide comfort to the market. Furthermore, the Reserve Bank has also conducted purchase of government securities under its open market operations (OMO). Such operations will be conducted as warranted by evolving monetary and financial market conditions.

The yield on the 10-year benchmark government securities, which hardened from 5.87 per cent on January 23, 2009 to 6.43 per cent on January 30, 2009, has since softened to 6.04 per cent on March 3, 2009. Taking the signal from the reductions in the repo and reverse repo rates in recent months, all public sector banks and several private sector and foreign banks have reduced their benchmark prime lending rates (BPLRs). Since the announcement of the Third Quarter Review, eleven banks have cut their BPLRs ranging from 25 basis points to 125 basis points. Several banks have also cut their deposit interest rates.

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