RBI cuts rates by 0.25%

The Reserve Bank of India, in its credit policy today announced a rate cut of 0.25% on both repo and reverse repo rates, to 4.75% and 3.25% respectively. The 10 year bond yield fell to 6.17%, after opening the day around 6.4% - yields tend to fall when interest rates do.

RBI expects 2010 growth of 6%, which in my opinion is wildly optimistic. But it does expect inflation to drop below zero - no marks for getting that right - and an overall annual inflation of about 4% in the next year. Of course, they believe that this isn’t deflation from lack of demand, but a general blip in an otherwise untarnished record of inflation. To me real lack of demand is a distinct possibility, but we’ll see how it goes in October.

Another significant announcement, is that the way savings bank account interest (currently 3.5%) is calculated - on the lowest balance between the 10th and the last day of the month - will be changed to a daily product rate. This probably means the end-of-day balance multiplied by a daily interest rate. It’s nice to cheer, but this does not apply till April 1, 2010, so don’t hold your breath.

Interestingly, the savings account rate at 3.5% is greater than the reverse repo rate of 3.25%. That means RBI is paying less to banks than they have to pay people for their savings account balances - so banks can balance out their SB liabilities by depositing extra cash with the RBI. They have to really lend. And they’re not going to, for multiple reasons: Lack of demand is one. So what will happen? Most likely, government bond rates will go up and so will t-bill rates. Of course, RBI can change the savings account rates too - but in election season, it’s highly unlikely.

Bank stocks got hammered today, with ICICI losing some 6% in the day. And the RBI policy does contain some interesting notes about fresh regulation, “stress” tests and such - warrants a deeper read.