The Reserve Bank of India unexpectedly cut its key deposit rate on Friday, for the second time in three weeks, to discourage banks from parking idle funds with it and spur lending instead, to revive a flagging economy amid the coronavirus lockdown.
This week, Prime Minister Narendra Modi extended until May 3 a lockdown of the population of 1.3 billion as India's tally of infections exceeded 10,000, despite the three-week shutdown ordered from March 24.
The RBI cut its reverse repo rate by 25 basis points (bps) to 3.75% with immediate effect, Governor Shaktikanta Das told a video conference. The rate had already been cut by 90 bps on March 27.
The central bank kept its benchmark lending or repo rate unchanged at 4.40% after a cut of 75 bps last month.
Since his last address on March 27, Das said, India's economic and financial landscape has "deteriorated precipitously" in some areas.
"The surplus liquidity in the banking system has risen significantly in the wake of government spending and the various liquidity enhancing measures undertaken by the RBI," he added.
"In order to encourage banks to deploy these surplus funds in investments and loans in productive sectors of the economy, it has been decided to reduce the fixed-rate reverse repo rate."
Indian banks had been extremely wary of lending over the last few quarters as the economy cooled, and those fears have only increased in recent weeks as business activity collapsed.
Banks have parked 4.36 trillion rupees ($57.02 billion) on average with the RBI over the last three weeks, highlighting the extent of surplus rupee funds in the system.
"It is doubtful whether this flow can be stemmed easily," said Joseph Thomas, head of research at Emkay Wealth Management.
"Banks are not lending or investing because they fear that under the current conditions they may be adversely impacted."
Both the NSE Nifty 50 index and the benchmark S&P BSE Sensex, which had risen more than 3% in early trade, trimmed gains as Das spoke. The Nifty was last up 1.59% at 9,136.05 by 0827 GMT, while the Sensex was up 1.68% at 31,116.47.
The RBI announced another round of targeted long-term repo operations and other regulatory measures for banks.
The new round of up to 500 billion rupees will be provided to banks as long as they invest these funds in investment grade bonds, commercial paper and non-convertible debentures of small, mid-size and large non-bank finance companies.
The RBI also opened a refinance facility for the National Bank of Agriculture and Rural Development, the Small Industries Development Bank of India and National Housing Bank to meet the long-term funding needs of various rural and small sectors.
"Today's announcements by RBI will greatly enhance liquidity and improve credit supply," Modi said on Twitter. "These steps would help our small businesses, MSMEs, farmers and the poor."
However, analysts believe the government will have to provide far more help to tide over the crisis.
It has announced a $22-billion package targeted at the poor but refrained from any "Big Bang" measures.
"We think more targeted coordinated fiscal and monetary measures may be needed with increasing growth downside risks backed by depth and longevity of COVID-19," said Madhavi Arora, a lead economist with Edelweiss.
Das said the central bank would monitor the situation and take further measures as and when required, while the expected trajectory of inflation would also open up space for policy action, barring any supply-side shocks.