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RBI Likely To Hold Rates, Eyeing Rupee, C/A Deficit

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A tumbling rupee and pressure on the current account deficit are likely to prevent the Reserve Bank of India from lowering policy rates on Monday despite softening inflation and decade-low economic growth. A policy hold would halt a cycle that has seen the central bank cut rates at each of its reviews in 2013.

A Reuters poll showed 28 of 38 analysts expected the RBI to hold the repo rate at 7.25 per cent, while 30 of 34 expect banks' cash reserve ratio, which is the share of deposits banks must keep with the central bank, to be left unchanged at 4.00 per cent.

"The rupee depreciation will allow the RBI to bolster its anti-inflation rhetoric in the June policy review. They might choose to pause this time due to the exchange rate weakness," said Tirthankar Patnaik, chief economist, Religare Capital Markets, who changed his expectation to no rate cut after the rupee's fall.

A weak rupee makes imports costlier, increasing inflationary pressure, and also prompts foreign investors to sell Indian assets as their dollar returns take a hit, increasing the difficulty of financing the current account deficit.
 
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The retail inflation for May eased for the third straight month to 9.31 per cent but was higher than an expected 9.05 per cent and far above wholesale price index inflation of 4.89 per cent in April, a key constraint for the RBI to cut rates faster even as factory output grew 2 per cent.

The rupee plunged to a life-time low of 58.98 to the dollar on Tuesday, on global dollar strength and worries over the country's current account deficit, making it the worst performer in Asia since May. As sentiment towards emerging market asset sours, foreign investors have sold a net $3.7 billion of Indian debt in 15 consecutive sessions.

"Certainly the risks to CAD (the current account deficit) have worsened after this sharp fall in the rupee. This will be an equally dominant factor as inflation, if not more, in policy making," one official with direct understanding of policymaking told Reuters, declining to be identified because of the sensitivity of the matter.

The RBI has cut its policy repo rate by 75 basis points in 2013 to 7.25 per cent but has warned of "little space" for further easing citing inflationary risks and saying the current account gap is the biggest risk for the economy.

The current account deficit, which touched a record high of 5.4 per cent of GDP in the April-December 2012 period, is expected to be around 4 per cent for the full fiscal year that started in April 2013, still way above the RBI's comfort level of 2.5 per cent of GDP.

Mind The Gap
Gold and oil imports which contribute to about 45 per cent of India' total imports, have been the biggest source of worry for the huge current account gap.

Imports in April rose an annual 10.9 per cent, driven by a surge in gold imports while exports rose only 1.6 per cent, taking the trade deficit to $17.8 billion.

While the government has deregulated petrol prices, diesel prices are only partially free, adding to the government's subsidy burden and fiscal deficit. Both the RBI and the government have also taken measures to curb gold imports including raising import duties and placing restrictions on gold imports by banks.

Policymakers expect these measures along with normal monsoon to help ease inflation pressure, but the RBI is unlikely to take comfort until both retail inflation and the current account deficit ease further.

(Reuters)
 


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