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RBI rate cut bonanza! Will banks too surprise us?

RBI Governor Dr. Raghuram Rajan has announced (i) a steep 0.50% cut in the policy interest rates, in his 4th bi-monthly monetary policy statement 2015-16 and (ii) other rate-slashing measures.

The moot question, however, is... will banks too cut rates on our loans? And, if yes, by how much; and when?

The Rate Cut
Prior to this, RBI had brought down the policy interest rates by a total of 0.75% in the calendar year 2015 (through three cuts of 0.25% each). Tragically, banks did not pass on the entire benefit to us. Most banks have cut our loan rates by only around 0.30%. The rest is going into their pockets.

On the other hand, however, RBI observes that banks have significantly reduced their deposit rates. Thus, they have adequate headroom to pass on further rate cuts to hapless borrowers.

Meanwhile, given that the inflation is likely to remain within the desired levels and economic growth needs a push, it has announced another "drastic" cut of 0.50% in the policy interest rates.

RBI will now focus on removing the bottlenecks, that do not allow transmission of the drop in interest rates, to the ultimate borrowers

This is real good news. We hope that, of the total 1.25% rate cut till date, maximum possible reduction is passed on to us; at the earliest.

rbi-cuts-interest-rates-sharply
Wow! Huge reduction in interest rate by the RBI. More to follow... 

More Rate Slashing initiatives
In addition to the substantial reduction in the interest rates, RBI has made a few more significant announcements in its 4th Bi-monthly Monetary Policy 2015-16.

a. By Nov 2015, RBI will announce a new methodology for banks to compute their base interest rates. This change is likely to bring about additional reduction in the borrowing rates that are linked to the base rates.

b. At present, banks have to compulsorily keep 21.5% of their deposits in government securities and gold. This is proposed to be reduced by 0.25% every quarter, from Jan 9, 2016 onward till Mar 31, 2017. This will release huge amount of cash for banks to lend to companies and individuals. Hence, the interest rates may further fall due to competitive pressures.

All-in-all, a great monetary policy by RBI Governor Dr. Raghuram Rajan.

Economic Assessment
Salient aspects of the RBI's economic assessment are listed below.

1. Both the economic growth across the world and global trade, are witnessing difficult times. Japan, China, Brazil, South Africa, Russia, Emerging Markets are all facing huge challenges. Only US and Europe are showing some signs of growth and stability.

2. Various currencies, commodities and equities too have suffered depreciation in recent months. As such, the financial markets worldwide remain weak and vulnerable.

3. In India, the agricultural sector may not suffer too much damage, despite the deficient monsoon this year.

4. The manufacturing sector has shown uneven growth in the last 4-5 months. Demand has remained weak. However, due to steeper fall in the input prices, the companies' margins have marginally improved.

5. Services too have shown some recovery, but the sentiments are still subdued.

6. There is a sharp drop in the inflation to a nine-month low figure.

7. Liquidity in the economy is quite comfortable.

8. India has added another USD 10.4 billion to its foreign exchange reserves.

9. Inflation expectations have been revised to 5.8% in January 2016, vis-a-vis 6% earlier.

10. However, the expected economic growth for 2015-16 too has been revised downward from 7.6% to 7.4%.

The Negative Impact
It is but natural that this will lead to a drop in the deposit rates too. So, fixed deposits, PPF, NSC, other post-office saving schemes, forthcoming issues of tax-free bonds, etc. will fetch lower returns going forward.

This is bad news for those depending solely on the interest income from their deposits.

However, one must look at the picture in totality. Lower lending rates lead to lower inflation. Lower interest rates lead to booming economy. Lower interest rates lead to higher salaries. These positives, more than offset, the loss due to lower deposit rates.

In other words, lower interest rates in the economy are beneficial for everyone.

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