Developments over the past week and more had made it clear that the economy was running into a stronger headwind than had seemed to be the case earlier.

The August numbers for the index of industrial production were a shock, reporting growth of barely 1.3 per cent -- the worst in many years.

The manufacturing sub-sector did even worse, with 1.1 per cent growth.

There may be good reason to believe that this is an aberration, but the corporate results so far for the second quarter have shown that margins are under pressure, and that topline growth is slowing.

These and other indicators have encouraged policymakers to shift their focus away from the inflation rate (which has peaked, and is now clearly on the decline) and to deal with liquidity and growth issues.

The measures announced by the government and Reserve Bank over the past fortnight (including a sharp 250-basis point reduction in the cash reserve ratio and a drop in the requirements for banks to invest in government securities) had served to pump an unprecedented Rs 140,000 crore (Rs 1,400 billion) into the system.

That dealt with the liquidity crisis in some measure, and set the stage for the use of another arrow in the quiver, interest rates.

That arrow has now been released into the system, with a substantial cut of 100 basis points in the repo rate, at which RBI lends to the commercial banks.

The timing of this announcement may not have been much of a surprise, considering that the scheduled quarterly policy announcement was only four days away, but the magnitude certainly was.

Last July, the repo rate was actually raised by 50 basis points. A swing of 150 basis points within a quarter is most unusual.

But, then, these are most unusual times and the RBI's assessment clearly was that any measures taken in these circumstances have to be bold and dramatic to have any chance of succeeding.

If growth were indeed slowing as dramatically as the IIP numbers suggested, the small movements that have come to characterise policy announcements over the past few years were unlikely to have enough of an impact on demand to reverse the tide very quickly.

With inflation much less of a worry factor than before, the rate cut was presumably seen as a risk worth taking.

The question is whether this will do the trick.

For, while the liquidity announcements made over the past fortnight helped ease overnight call money rates, they did not have the intended effect elsewhere, because banks continue to hold more government securities than they are required to; they are therefore lending less than they can, even though there is a desperate requirement for funds in many sectors.
Clearly, there is doubt in bankers' minds about the quality of assets in some sectors -- specifically, real estate and the debt mutual funds.

With that being the case, no one should expect any immediate pass-through impact on bank lending rates -- unless of course the government leans on the state-owned banks to fall in line with policy intentions.

In other words, there is a toxic assets problem that still has to be dealt with, and on this there are no easy answers.

Still, the interest rate cut will have a positive impact on money market sentiment, and will also improve the value of the paper that the debt mutual funds have been holding (thus giving them some leeway for encashing assets to meet redemption pressures).

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