Mumbai, Aug. 23: A decline in inflation and a good monsoon has prompted the Reserve Bank of India (RBI) to cut the repo rate, its key short-term rate, by 50 basis points to 4.5 per cent.
The cut, effective Monday, signals the persistence of a softer interest rate regime. It immediately led to government security prices leaping by Rs 1.50 and yields on the benchmark 10-year security diving to 5.35 per cent.
While bond market experts believe that government security yields are set to go down further over the next few days, interest rates on bank deposits could also take a hit as a result of the RBI move.
Repo is the rate at which the RBI borrows funds from the market and which banks use to benchmark short-term deposits and loans
The RBI today said that in view of the current macroeconomic and overall monetary conditions, it is bringing down the one day and 14 day repo rate under the Liquidity Adjustment Facility (LAF) to be made available on August 25 to 4.5 per cent from 5 per cent.
Thereafter, as per the current practice, the cut-off rate for acceptance of bids for one day and 14 day repo will continue to be decided by the Reserve Bank at each auction.
The RBI had earlier pointed out that it was closely watching the inflation situation and the monsoon before deciding on a cut.
The annual rate of inflation, which was about 6.7 per cent as on April 5, 2003, has progressively come down to 3.95 per cent as on August 9.
“The monsoon has also been good and widespread. The good monsoon has raised expectations of a good kharif crop. The reduction in the repo rate by 50 basis points will also help in making the yield curve less flat compared to the current situation,” the central bank said.
Speaking to The Telegraph, Sharukh Wadia, senior vice-president and head of treasury of IndusInd Bank, said that yield on the benchmark 10-year security could pierce the 5.25 per cent level by September.
Today the benchmark 10-year security closed at 5.36 per cent, a fall of around 20 basis points over its previous finish. He added that the RBI move may also affect deposit rates and advances of banks.
While speculations of a reduction in repo rate was doing the rounds couple of months back, the central bank had maintained that this would not be done until the monsoon and inflation situation became more clear. As a result, today's cut took most by surprise.
“The market did not expect it to be done today, though a repo rate cut was overdue. Some of us thought that when Y. V. Reddy would assume charge as the governor, it would be brought down,” Wadia said.
An RBI spokesperson said that while the overnight repo rate will be 4.5 per cent on Monday after the present cut, the State Development Loan, 2015 for Rs 8000 crore with a maturity of twelve years will be sold on tap at 6.20 per cent on that day.