RBI soothes markets with a surprise 0.25% cut in repo rate

The Reserve Bank of India (RBI) on Thursday cut the repo rate - the rate at which it lends to commercial banks – by 0.25 percentage point to 7.75 per cent from 8 per cent, in a bid to cool markets that are demanding a reduction in lending rates to spur business activity.

RBI governor Raghuram Rajan has also been under pressure from the government to cut rates to boost market sentiments and add momentum to economic growth.

The stock market greeted the announcement with a 600-point jump in the Bombay Stock Exchange sensitive index, Sensex, which inched closer to the 28,000-mark in opening trade.

The Nifty climbed 176.05 points to trade to 8,453.60.

RBI kept the cash reserve ratio (CRR) of scheduled banks unchanged at 4.0 per cent of net demand and time liabilities (NDTL).

RBI said it would continue to provide liquidity under overnight repos at 0.25 per cent of bank-wise NDTL at the LAF repo rate and liquidity under 7-day and 14-day term repos of up to 0.75 per cent of NDTL of the banking system through auctions; and continue with daily variable rate repos and reverse repos to smooth liquidity.

The reverse repo rate under the LAF now stands adjusted to 6.75 per cent, and the marginal standing facility (MSF) rate and the Bank Rate to 8.75 per cent with immediate effect.

Announcing the rate cut, RBI governor Raghuram Rajan said the easing of inflationary pressures since July 2014 as measured by changes in the consumer price index has been consistent with the assessment of the balance of risks in the RBI's bi-monthly monetary policy statements.

To some extent, lower than expected inflation has been enabled by the sharper than expected decline in prices of vegetables and fruits since September, ebbing price pressures in respect of cereals and the large fall in international commodity prices, particularly crude oil.

Crude prices, barring geo-political shocks, are expected to remain low over the year. Weak demand conditions have also moderated inflation excluding food and fuel, especially in the reading for December. Finally, the government has reiterated its commitment to adhering to its fiscal deficit target.

These factors, he said, have significantly reduced the momentum of inflation, compensating for the widely anticipated ending of favourable base effects.

Inflation outcomes have fallen significantly below the 8 per cent targeted by January 2015. On current policy settings, RBI expects inflation to be below 6 per cent by January 2016.

These developments have provided headroom for a shift in the monetary policy stance.

It may be recalled that the fifth bi-monthly monetary policy statement of December had stated that ''if the current inflation momentum and changes in inflation expectations continue, and fiscal developments are encouraging, a change in the monetary policy stance is likely early next year, including outside the policy review cycle''.

In its public interactions, the RBI had committed to initiate the process of monetary easing as soon as data indicated that medium term inflationary targets would be met. Keeping this commitment in mind, it has been decided to:

RBI also announced an overnight repo variable rate auction for a notified amount of  Rs20,000 crore today (15 January 2015). The reversal of the overnight repo will take place on 16 January 2015 (Friday).