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RBI paves the way for funds inflow; Indian banks finally slash rates

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October 20
1:32 AM 2015

The Reserve Bank of India (RBI) Governor Raghuram Rajan's latest measure to slash benchmark repurchase rate is finally giving results as commercial banks started cutting down interest rates.

Commercial banks have reduced interest rates by 70-125 basis points this year so far. Prime Minister Narendra Modi-led government is relying on cheaper loans to boost investment to propel credit growth, which is hovering at 20-year low.

Allowing foreign investors into Indian bonds has also pushed yields lower. Indian economy is growing at seven percent annually.

The Rajan's strategy weakened the resistance from banks in passing on the benefit of policy rate cut to customers. RBI reduced repurchase rate higher than market expectations.

After reducing repurchase rate, banks have started reducing interest rates. Of the total reduction in the range of 70-125 basis points year-to-date (YTD), half of which has been during the past few weeks only.

The Indian government in 2014 allowed foreign investors into bonds and this pulled the yields to lowest since July 2013. A year later, banks would be forced to align their lending costs with market rates.

The transmission of passing on the lower interest rate benefit to customers was not encouraging before policy meeting in September. The latest reduction in repurchasing rate and other measures from RBI are resulting in more monetary transmission, opine banking analysts.

Rajan cuts central bank's main rate twice this year.  Contrary to market expectations that rate cut would be to seven percent, Rajan slashed it to 6.75 percent. Rajan managed to keep inflation rate well below the government's target of six percent at 3.7 percent.

The medium-term target of inflation rate is four percent. The current inflation rate is even below this. Though Indian economy is growing at seven percent, still it needs stimulus, feel economists.

The first half of his three-year term, Rajan was focusing on rupee stabilization and checking inflation rate, which is considered to be fastest among Asian economies. Rajan aims to shift the total banking model to market-driven model. From 1 April onwards, all the commercial banks need to adopt a new method of lending costs. 

Major lenders in the country SBI, Axis Bank, ICICI, HDFC, Bank of India, Andhra Bank, etc, started slashing down their interest rates with an objective of passing on the benefit to customers.

The rate cut will result in the reduction of EMIs (equated monthly installments) for customers. However, banks have yet to transmit the total benefit of RBI's cut in benchmark rate to customers. 

According to the new norms, overseas investors can hold up to five percent of total outstanding debt by March 2018. The current cap is 3.8 percent. The raising cap will result in the inflow of INR 1.2 trillion ($18.4billion). 

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