The repo rate cut will encourage banks to pare their deposit rates, thereby bringing down the cost of funds. Besides, it will also trigger flaring of gilts prices which may help banks book depreciation benefits on account of lower yield to maturity (YTM) of the government papers.

The issue is likely to come up for discussion at the bank chiefs meeting with Reserve Bank of India deputy governnor SP Talwar on Thursday. The RBI has called the meeting to discuss a detailed framework for asset liability management in banks. A separate meeting on Y2K compliance will also be held by the RBI which will also be chaired by Talwar later in the day.

The repo rate is currently pegged at 8 per cent. The last time the Reserve Bank hiked the rate was in August last year after speculators attacked the dollar and weakened the rupee to a low of 42.70.

The move for a repo rate cut developed steam after the inter-bank call rates tightened to cross the psychological barrier of 10 per cent on Wednesday.

Bankers have been lobbying for a repo rate cut as it will help them boost the declining spread on their assets. "Even though there is no pick up in credit, we cannot lower the deposit rates unless we get a signal from the central bank...The repo rate cut will send out the signal," a private sector banker said.

The repo rate cut will also inject bullishness in the bond market triggering a rise in prices. With the decline in yields, banks will be in a position to benefit on account of depreciation in gilts. The YTM for the 10-year paper in 1998 was fixed at 12.15 per cent. At present, the 10-year paper currently is trading at 12.22 per cent. "If the RBI cut the repo rate, the YTM on the 10-year paper will fall below the 1998 level," one banker said.

Jalan had last week made a statement in Delhi that interest rates should head down. However, this was preceived to be a general statement and not a signal for an impending repo rate cut. RBI sources said the Thursday meeting is unlikely to discuss the interest rates scenario even as senior bankers are determined to raise the issue.

"There is a case for the RBI to cut the repo rate by one percentage point," SBI Caps debt analyst Ashish Aggarwal said. According to him, the rupee is stable and the volatility in the Asian currency markets has died down. Hence, external factors for the rupee instability are ruled out. Moreover, the central bank is still monitoring the peak level forex transactions in the inter-bank market which will stop banks to speculate on the rupee.

Another factor that can lead to a cut in the repo rate is the fact that the six-month forward rupee is ruling around 6.3-6.4 per cent (annualised) while call rates are hovering around 10.50 per cent. "There is no chance of arbitrage and a fresh attack on the rupee as local currency funds are costlier than dollar funds," Aggarwal said.

A repo rate cut to 7 per cent will see call rates being benchmarked to 7 per cent--nothing below--making rupee funds still unattractive compared to the six month dollar.

Insight -- a logical move

Bankers are understandably keen to push for a repo rate cut, as that would lead to a downward movement in the entire structure of interest rates. The recent downward revision in post office savings rates could be used as an excuse. Bank bottomlines are under pressure because of sluggishness in credit offtake and mounting NPAs, and if the mark-to-market rates for government securities at the end of the fiscal year do not come down, many banks will have to provide for depreciation on their securities portfolio, further hitting profits. A lower mark-to-market rate, a likely consequence of a repo rate cut, would help banks shore up their bottomlines.