Reserve Bank Of India is doing its best to arrest slow down of economic growth. It announced reduction in bank rate and cash reserve ratio in its mid term monetary policy. The bank rate is reduced by 50 basis points to 6.50 percent, lowest in the last 28 years. The cash reserve ratio is reduced to 5.50 percent from 7.50 percent.
The reduction in interest rate is expected to improve investment and consumption which in turn is expected to improve demand for goods and services. There is a constant complaint form the industrial class in the country that the cost of capital in the country is high. The present reduction in bank rate fits into the governments long term plans to make cost of capital attractive for investment. One has to wait and see how much this policy initiative will translate into actual investment.
If the reduction in bank rate is passed on to the retail borrowers then the demand for goods and services will definitely increase. India has a large population who save rather than consume. The country’s saving is 20 percent of GDP which is high even compared to some developed nations. The reduction in interest rate, both on saving and loans can act as an incentive to consume which in turn can improve demand. For banks average cost of funds is 7 percent, operating expenses add another 2.5 to 3 percent to the costs. Another important cost factor for the Indian banking sector is the bad debts shown as non performing assets in the balance sheet of the banks.
Cash reserve ratio (CRR) is the cash balance which banks have to park with central bank. Estimates are that the reduction in cash reserve ratio will infused Rs 8000 crore into the system. This is a quick way to make sure that the supply side is in order when there is an increase in demand for credit. The central bank will also pay 6.5 percent to the banks for the CRR balance which will improve the profitability of the banks.
The economy of the country is not the best of times, GDP growth of 6 to 6.50 percent estimated by the RBI in the beginning of the year has been revised to 5 to 6 percent by the bank. Manufacturing sector is down along with poor performance in the exports, added to this is the global economic trouble after September. Many feel that the mid term monitory policy may help at least to boost up sentiments in the economy.