29/09/2015 11:22 AM IST | Updated 15/07/2016 8:25 AM IST

RBI Heavily Slashes Lending Rates By Half A Percent

Reserve Bank of India (RBI) Governor Raghuram Rajan speaks during a press conference in Mumbai, India, Tuesday, June 2, 2015. India's central bank cut a key interest rate by a quarter percentage point Tuesday, the third such reduction this year in support of government efforts to boost growth. (AP Photo/Rafiw Maqbool)

RBI governor Raghuram Rajan cut key lending rates by an unprecedented half-percentage point to stimulate the economy. Though analysts and the markets did expect the bank to slash rates, the quantum has surprised them. The bank has however let another key metric, the Credit Risk Ratio, remain unchanged at 4%.

The repo rate is the level at which the central bank lends to commercial banks and Rajan has been under pressure, from various sections of the government, to boost growth after inflation hit a record low of 3.6% in August due to falling commodity prices.

The rate cut would mean lower home loan rates as well as reduced equated monthly instalments, though matters could swiftly change over coming months if global commodity prices start to rise and the US Fed finally decides raise interest rates and tighten the tap on cheap money. Both of these imponderables, for now, appear some time away.

The RBI's press statement explains that the decision was prompted by a tepid world economy and positive--but still sluggish--macro economic conditions in India. In India, a tentative economic recovery is underway, but is still far from robust.

The benchmark repurchase rate to 6.75 percent from 7.25 percent. “The weakening of global activity since our last review suggests that commodity prices will remain contained for awhile,” Rajan said. Stronger domestic demand is needed to substitute for weaker global growth, he said, adding that “monetary policy has to be accommodative to the extent possible” in current conditions.

According to Bloomberg, Rajan is looking to keep inflation within 6 percent by January, 5 percent a year later and near 4 percent by early 2018.

Rajan said the January target “is likely to be achieved” and “the focus should now shift to bringing inflation to around 5 percent” by March 2017. The bank will be vigilant for signs monetary policy adjustments are needed to stick to the deflationary path, he said.

According to Firstpost, Rajan has so far cut interest rates by a cumulative 75 bps and has expressed concerns that banking industry hasn't done enough to effect these cuts into lower lending rates. Over-leveraged balance sheets of corporations, lessens the chances of any immediate pick-up in credit growth even if the RBI cuts the repo rate by another quarter percentage point.

Rajan by himself is relatively unperturbed by his actions.

The markets, which had lost nearly 1%, made a brief recovery on the back of Rajan's announcement, but have again slipped back into negative territory.

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