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India’s central bank lowers interest rate

Policy easing to infuse an extra 180 billion rupees into the economy

  • Reuters
  • Published: 17:14 January 29, 2013
  • Gulf News

  • Image Credit: AP
  • Clothes on display at a shopping mall in Bengaluru. India’s central bank cut its GDP growth forecast for Asia’s third-largest economy to 5.5 per cent for the current fiscal year, from 5.8 per cent previously.

Mumabi: 
India’s central bank lowered its key policy rate for the first time in nine months on Tuesday, but struck a cautious note on further easing as it waits to see how the government’s upcoming budget aims to bring a bloated fiscal deficit under control.

The Reserve Bank of India cut the policy repo rate by 25 basis points (bps) to 7.75 percent to help support an economy set to post its slowest annual growth rate in a decade.

The size of the cut was in line with forecasts in a Reuters poll of analysts earlier this month. The central bank gave guidance back in October that it could reduce rates during the January-March quarter, and Indian bond and stock markets were largely unmoved as dealers had already priced in the move.

But the RBI unexpectedly also reduced the cash reserve ratio (CRR), the share of deposits that banks must keep with the central bank, by 25 bps to 4.00 per cent, which will infuse an extra 180 billion rupees ($3.4 billion) into the banking system.

The central bank stressed that halting a slide in growth had become critical, but it went on to list constraints, notably worryingly high current account and fiscal deficits, and the risk that inflation could flare again.

“Monetary policy stance has sought to balance the growth-inflation dynamic through calibrated easing,” the RBI said in its quarterly monetary policy review.

“It is now critical to arrest the loss of growth momentum without endangering external stability.”

Inflation

India’s headline inflation rate moderated to a three-year low of 7.18 per cent in December, and the central bank said there was likelihood that inflation would remain range-bound around current levels entering the 2013/14 fiscal year starting April.

“This provides space, albeit limited, for monetary policy to give greater emphasis to growth risks,” the central bank said.

Having grown at near-double-digit pace before the Lehman Brothers crisis, the economy has suffered a rapid deceleration.

The RBI cut its GDP growth forecast for Asia’s third-largest economy to 5.5 per cent for the current fiscal year, from 5.8 per cent previously, and lowered its projection for headline inflation in March to 6.8 per cent from 7.5 per cent earlier.

Though respectable by other standards, the growth rate is too slow for a country trying to support hundreds of millions of poor people, and is a worry for the ruling Congress party as it heads towards an election next year.

Eyes will now fall on Finance Minister P. Chidambaram’s annual budget statement due in late February, to see how the government plans to put its finances in order.

While measures taken by the government to bring the fiscal deficit within a targeted 5.3 per cent of GDP have reduced near term risks, cuts in politically sensitive subsidies were needed for sustainable fiscal consolidation, the RBI said in an economic report issued a day before the policy review.

Shakti Satapathy, a fixed income strategist with AK Capital in Mumbai, was hopeful that the budget would pave the way for another RBI rae cut in March.

“We expect another 25 bps rate cut at the March policy meet,” Satapathy said. “The qualitative fiscal management measures (taken) during the upcoming budget session would be the guiding factor in deciding the quantum and timing of future rate cuts in the next fiscal (year).”

Endorsement
Montek Singh Ahluwalia, deputy chairman of India’s Planning Commission, regarded the RBI’s easing as an endorsement of steps taken by the government to tackle its deficit.

“I think what it signals is the RBI feels that the government has taken a number of steps which gives the fiscal space needed for monetary policy to support growth,” Ahluwalia said, adding that the economy was beginning bottom out.

Last September, Prime Minister Manmohan Singh’s fractious coalition ended a debilitating phase of policy inaction to make urgently needed reforms to reduce the fiscal deficit and attract foreign investment to help the current account deficit and growth.

The measures, which included giving foreign players more access to its retail and aviation sectors, helped India forestall the threat of a sovereign debt credit rating downgrade to junk status.

Recently, as part of an ongoing drive to trim spending, the government gave oil companies more room to set regulated diesel prices.

The current account deficit (CAD) touched a record high of 5.4 percent in July-September and is likely to rise further in the December quarter, according to the central bank’s economic report.

“Financing the CAD with increasingly risky and volatile flows increases the economy’s vulnerability to sudden shifts in risk appetite and liquidity preference, potentially threatening macroeconomic and exchange rate stability,” the RBI said.

For now though, India markets appeared content with the RBI’s measured easing. Benchmark government 10-year yields were largely unchanged at 7.87 per cent, while the National Stock Exchange index was up 0.3 per cent, with the bank sub-index up 1.3 per cent.

The Indian rupee strengthened to 53.62 per dollar from around 53.84 before the decision.

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