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'Very Limited' Room To Ease Policy, Warns RBI

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The Reserve Bank of India on Thursday, 2 May 2013, warned of "very limited" space for further easing of monetary policy, striking a hawkish tone a day before it is widely expected to cut interest rates by 25 basis points for the third time this year.

The cautious language in its report on macroeconomic and monetary developments could dent rising market hopes for a dovish stance from RBI Governor Duvvuri Subbarao on Friday and further easing this year.

"In view of macro-financial risks that stay significant, headline inflation remaining above the threshold and consumer price inflation remaining high, the space for action for 2013-14 remains very limited," the RBI said on Thursday.

The central bank's Macroeconomic and Monetary Developments report said that even while macro-financial stability risks have started getting addressed, they remain significant at current juncture.

"This necessitates careful calibration of monetary policy during 2013-14," RBI said.

It said the impact of monetary policy in boosting GDP growth is contingent upon resolution of supply bottlenecks, governance issues impeding investments and the government's efforts towards fiscal consolidation.

"Growth continued to slow down in 2012-13, but could witness a slow-paced recovery later this year, contingent on improved governance and concerted action to resolve structural bottlenecks," RBI said.

It further said a revival in growth in the current fiscal is likely, but the recovery would be modest against the backdrop of stagnating industrial output.

Noting that the recent fall in the prices of gold and crude give a "much needed relief", it said being complacent on a temporary phenomenon would be "myopic".

RBI reduced key interest rate by 1 per cent during 2012-13 and pressure is mounting on it to further cut rates in the annual policy to boost growth, which fell to a decade's low of 5 per cent in the last fiscal.

The RBI is expected to cut the policy repo rate by 25 basis points to 7.25 per cent on Friday, 3 May amid easing headline inflation and an economy growing at its slowest in a decade. However, the outlook for further cuts is tempered by a high current account deficit and still-high inflation.

The RBI's survey of professional forecasters lowered its growth forecast for the fiscal year that started in April to 6 per cent from 6.5 per cent in its previous survey. Asia's third-largest economy is expected to have grown at about 5 percent in the fiscal year that ended in March.

The survey projects wholesale price index inflation at 6.5 per cent during the current fiscal year, lower than the 7 per cent forecast in its last survey. The RBI said inflation could ease further in the first half of the fiscal year before rising slightly in the second half.

On inflation, the report said the trend of downward spiral will continue through first half, while suppressed inflation in form of upward revision in energy prices and a base effect will lead to an increase in the second half.

The nearly 20 per cent fall in commodity prices, and inflation at a 3 year low of 5.96 per cent in March, has led to expectations among the industry of cut in key policy rates.

RBI conceded that its policy rates have been one of the reasons for the growth to dip, but maintained that a rate cut alone will not drive up the growth.

"Recovery at the current juncture will critically depend on supply-side action to remove a host of micro-constraints and structural bottlenecks that impede production and investment, especially in growth driving sectors such as road and power," RBI said.

The central bank also called for a public investment stimulus "balanced with offsetting reductions" in expenditures, along with removing the supply side bottlenecks, to revive the economy.

The report also said that if the government continues with its recent efforts of curbing expenditure in order to meet the fiscal consolidation target, it is likely to reduce pressure on the CAD.

The CAD/GDP ratio rose to a record 6.7 per cent in third quarter of 2012-13. RBI said that notwithstanding likely improvement in last quarter, the CAD/GDP ratio is expected to be at a new high of around 5 per cent for the year 2012-13, which is about twice the sustainable level.