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An unexpected interest rate cut by the Reserve Bank of India was a strong signal to banks that they should go out and lend instead of sitting on cash or parking the money in government bonds.

Having raised money at high rates to battle an unprecedented liquidity crunch, banks will prefer to cut deposit rates first before lowering interest on loans to consumers and corporates. But they know that the one percentage point cut in the repo to 8%—the rate at which banks borrow from RBI—marks the beginning of a dovish monetary policy, with inflation becoming less of a concern. RBI had last cut the repo in 2004.

Significantly, the announcement came just 3 days before RBI’s credit policy and during the market hours—something that RBI rarely does. The somewhat hurried cut may have been aimed at not just nudging banks to lend but also livening up the stock market.

According to Deepak Parekh, chairman of India’s biggest mortgage house, HDFC, “An effort is being made to bring back normalcy. Until last weekend, there was reluctance among banks to lend. And even if they did, it was at 16% to top corporates. We have to see whether the repo rate cut brings back normalcy.”

The move—which could gradually smoothen working capital flow to companies and lower their fund cost—enthused the stock market, with the Sensex hitting a high of 10,538.05 points, before slipping to 10,223.09 at close, up 247.74 points. “Not much can be expected until companies are actually able to borrow money from banks. Wait for the money to enter the system,” said SBICAP Securities research head Anil Advani. The Nifty gained 48.55 points to close at 3,122.80.

According to the treasurer of a leading bank, many banks will await RBI’s policy statement and the liquidity position before announcing a rate cut. Only Union Bank of India has announced a 0.5 percentage point rate cut on home loans up to Rs 30 lakh. Though RBI has unlocked funds by cutting banks’ cash reserve ratio, dollar selling by the central bank to hold the rupee is drying up some of the liquidity.

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