In an effort to arrest rising food inflation and providing relief to the "aam admi" as well as to revive investment, the RBI on Tuesday cut key policy rate by 0.25 points, which was also the second consecutive cut in less than 90 days.
Banks, however, indicated that they would like to wait till the current fiscal to end before taking any decision towards reducing lending rates, which would benefit home and auto loan seekers.
In its mid-quarter policy review, the RBI reduced the short term lending rate or the repo rate by 0.25 per cent to 7.5 per cent. The short-term borrowing rate or reverse repo rate would also subsequently come down to 6.5 per cent. However, the Cash Reserve Ratio (CRR) has been retained at 4 per cent on the expectation that Government will start spending more.
Markets though tanked on the double impact of the RBI action as well as key UPA ally DMK withdrawing support from the Government. The BSE Sensex closed down by 285 points. Realty and banking stocks fell by up to 5.5 per cent as market sentiment was hit by Reserve Bank's statement that scope for future rate cuts is limited.
The market was widely expecting a 0.25-0.50 per cent cut due to the falling growth which is estimated to touch a decade low of 5 per cent and a cooling in the core inflation to a 35 month low.
Although industry chambers were happy with the quantum of reduction by the RBI, they were not wholly satisfied, having wanted deeper cut.
RBI on its part said that the headroom is limited for further easing of rates on account of high food inflation and current account deficit.
"The foremost challenge for returning the economy to a high growth trajectory is to revive investment. A competitive interest rate is necessary for this but not sufficient," it said.
RBI Governor D Subbarao, however said, "...Even as the policy stance emphasises addressing the growth risks, the headroom for further monetary easing remains quite limited."
Commenting on RBI policy action, Planning Commission Deputy Chairman Montek Singh Ahluwalia said, "this policy gives signal in the right direction."
On the CAD, the RBI said the risk remains significant notwithstanding the likely improvement in fourth quarter and added, "financing of the CAD with stable flows remains a challenge".
Commenting on liquidity management, which was mentioned by Finance Minister P Chidambaram on Monday, the RBI said it will continue using all instruments including Government bond buybacks to inject liquidity.
RBI retains the growth and inflation forecast at 5.5 per cent and 6.8 per cent respectively for the current fiscal.
Commenting on the RBI policy action, Indian Overseas Bank Chairman and Managing Director M Narendra said, "banks would cut the lending rate when deposit rates, both short-term and long-term, start showing a decline. Base rate may not be cut at this point of time."
Terming the monetary action as on expected lines, Bank of Baroda Chairman and Manging Director S S Mundra said, "there is certain direction which is visible to us. I don't see any immediate action. But come April or mid-April there would be much clarity on liquidity position."
Ficci President Naina lal Kidwai said, "the RBI's decision to go in for another round of policy rate cuts was very aptly timed and was almost indispensable to revive the confidence of industry."
The RBI stressed that an interest rate cut alone will not be helpful in order to achieve the objective of reviving investment and called for bridging supply constraints and staying course on fiscal consolidation.
"The Government has a critical role to play in this regard by remaining committed to fiscal consolidation, easing the supply bottlenecks and improving governance surrounding project implementation," RBI said, acknowledging the "firm commitment" to fiscal consolidation made in the budget.
On its guidance, the statement was cautious on further easing and pointed towards the rising current account deficit- which is widely expected to touch a record high at 5 per cent and the expectation of inflation staying range-bound due to fuel price revisions and rising MSPs for agri produce, as the inhibiting factors.
This is the third time that the RBI has cut repo rate this fiscal. last, it had cut repo and CRR by 0.25 per cent each in January.
Following easing of monetary policy by the RBI in January, several lenders, including State Bank of India (SBI), Indian Overseas Bank, Bank of Baroda and IDBI Bank had cut lending rates.