MUMBAI (TIP): Reserve Bank of India governor Raghuram Rajan cut key interest rates — for the first time in almost two years — by 25 basis points about a fortnight ahead of the monetary policy review on February 3. Home and consumer loan rates are set to fall, as is the cost of capital for doing business.

The RBI had been under growing pressure from industry and reportedly the government to lower rates in the hope that it would stimulate growth. There had been speculation in the media that the finance ministry was unhappy with Rajan for being too focused on keeping inflation in check, and ignoring the need to get the economy back on track.

Raghuram Rajan RBI

Banks have responded to the mid-term move by bringing down lending and deposit rates and are forecasting more rate cuts in coming months.

Government-owned United Bank of India and Union Bank of India were the first off the block, nipping the base rate by 25 basis points to 10%. The base rate is the benchmark rate set by every bank to which the pricing of all its floating rate loans is linked.

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Other large lenders are expected to follow suit. State Bank of India chairman Arundhati Bhattacharya said that a cut in rates was on the bank’s horizon and there was some preparedness to do so but the timing would be decided by the asset-liability committee. HDFC vice chairman and CEO Keki Mistry said lenders were expected to pass on benefits of lower interest rates to customers by February.

Finance minister Arun Jaitley, who had been making a case for lower interest rates, said the move would provide a fillip to the economy directly by increasing the private sector’s ability and willingness to spend. “It should also help indirectly by improving the balance sheet of the corporate sector and banks, facilitating an increase in the demand and supply of credit,” said a statement from the FM. While the lower inflation numbers and drop in international crude prices have worked in favour of a rate cut, what appears to have emboldened RBI to go in for a mid-term move is the sharp fall in inflation expectation in RBI’s household survey.

The RBI decision came as a surprise although Rajan had indicated in the last policy review in December that he would be open to reducing rates early- 2015 even “outside the policy review cycle if the current inflation momentum and changes in inflation expectations continued”. Extending his wishes to the people on Thursday on the occasion of Makar Sankranti, Pongal and Uttarayana, Rajan said,
“Inflation outcomes have fallen significantly below the 8% targeted by January 2015. On current policy settings, inflation is likely to be below 6% by January 2016. These developments have provided headroom for a shift in the monetary policy stance”. According to data released by the government, retail price increase as measured by the consumer price index was 5.2% in December — much below RBI’s best case scenario as forecast in its monetary policy.

Market dealers said another trigger for the RBI decision might have been the release of the US Fed’s ‘Beige Book’ Wednesday night showing some slowdown in growth in oil-producing areas in the country, an effect of the recent crash in crude oil prices. It also revealed little pressure on wages or prices to rise. All these indicated that rates in the US may not rise as quickly as expected now.

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