The RBI Governor, Dr D. Subbarao, cut key policy rates for the first time in 3 years on Tuesday.

The repo rate (the rate at which the RBI lends money to banks) was cut by 50 basis points from 8.50 per cent to 8.00 per cent. Consequently, reverse repo rate (normally fixed at a spread of 100 basis points below the repo rate) is now 7.0 per cent.

The marginal standing facility rate, which has a spread of 100 basis points above the repo rate, is now at 9.0 per cent.

Banks have been given some relief on the liquidity front. The RBI has decided to raise the borrowing limit of scheduled commercial banks under the marginal standing facility (MSF) from one per cent to two per cent of their net demand and time liabilities.

Inflation target

The move to cut rates comes in the backdrop of a slowdown in growth which decelerated to 6.1 per cent in the third quarter of last year. Headline WPI inflation had moderated to below 7 per cent by end March although there are fears that it will flare up again. The RBI has, therefore, played it safe by projecting an inflation target of 6.5 per cent by March 2013. Its GDP projection for this year is 7.3 per cent.

The RBI had given guidance in January that it would reverse its tightening cycle.

There was a pause for two quarters on key policy rates although there was relief on the liquidity front with 125 basis points CRR cut, done in two stages in January and March. This released Rs 80,000 crore into the system. The RBI also injected about 1.3 lakh crore through open market operations. The liquidity crunch at that time, as depicted by bank borrowings in the repo window of the order of 2 lakh crore, has since moderated to around Rs 70,000 crore now.

The RBI flagged all its usual concerns and risk factors to its projections of growth and inflation. They were oil prices, the credibility of fiscal deficit numbers, crowding out effect of government borrowing, difficulties of financing a high current account deficit and persistently high food inflation.

Guidance

The guidance that the RBI gave (to put it simply) were:

1. Don't expect further cuts. Inflationary risks are still high.

2. Unless the Government cuts subsidies, demand pressures will continue and reduce scope for further cuts. Petrol prices need to be raised.

3. Liquidity conditions are returning to the comfort zone of the RBI, as banks are borrowing lesser amounts in the repo window. But lest banks take that as a hint, warnings of appropriate action have been issued.

The RBI also announced some development and regulatory measures in its annual policy.

1. Another no-frills account : In a variation of its 'no-frills' accounts, banks have been told to offer a ‘basic savings bank deposit account’ with certain minimum common facilities and without the requirement of a minimum balance to all their customers.

2. No Prepayment penalty : Banks will be mandated not to levy foreclosure charges or pre-payment penalties on home loans extended on a floating interest rate basis.

3. UID No. for everyone by March 2013 : Banks are being advised to initiate steps to allot a unique customer identification code (UCIC) number to all their customers.

4. On Basel III , final guidelines will be issued by end-April 2012, and final guidelines on liquidity risk management and liquidity standards by end-May 2012.

5 . Curbing gold loan NBFCs:

First, banks should reduce their regulatory exposure ceiling to a single NBFC, having gold loans to the extent of 50 per cent or more of its total financial assets, from the existing 10 per cent to 7.5 per cent of bank’s capital funds.

Second, banks should have an internal sub-limit on their aggregate exposure to all such NBFCs, having gold loans to the extent of 50 per cent or more of their total financial assets, taken together.

>vageesh@thehindu.co.in

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