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RBI Holds Repo Rate, Cuts CRR by 25 Bps

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The Reserve Bank of India on Monday left interest rates unchanged but cut the cash reserve ratio for banks by 25 bps, saying the primary focus of monetary policy remains fighting inflation, days after the government unveiled a spree of reforms to boost growth and improve its fiscal position.
 
The RBI left the policy repo rate at 8 per cent, in line with expectations in a Reuters poll on Friday before the government unexpectedly announced measures to allow foreign direct investment in industries including supermarkets and airlines.
 
On Thursday, the government announced a sharp increase in the price of heavily subsidised diesel.
 
The RBI cut the cash reserve ratio, the share of deposits banks must keep with the central bank, by 25 basis points to 4.5 per cent in a move it said will inject about Rs 17,000 crore of liquidity into the banking system.
 
"I suspect the RBI still wants to see inflation pressures move lower before easing policy further. (There) is also the risk that the recent round of government reforms could come unstuck if opposition in India is strong enough," said Jonathan Cavenagh, currency strategist at Westpac in Singapore, adding that he thought a rollback of those moves is unlikely.
 
The rupee and bond prices weakened immediately after the RBI decision, with the yield on the 10-year bond rising 5 basis points from before the RBI statement to 8.17 per cent. The one-year swap rate rose 8 bps to 7.68 per cent from before the release.
 
The Sensex also trimmed gains.
 
"The government's recent actions have paved the way for a more favourable growth-inflation dynamic by initiating a shift in expenditure away from consumption (subsidies) and towards investment (including through FDI)," the RBI wrote in its policy statement.
 
"However, in the current situation, persistent inflationary pressures alongside risks emerging from twin deficits -- current account deficit and fiscal deficit -- constrain a stronger response of monetary policy to growth risks," the RBI said.
 
 
In an unexpected 24-hour frenzy last week, New Delhi unveiled a slate of measures to rein in a ballooning fiscal deficit and avoid a credit rating downgrade to junk.
 
The RBI has held borrowing costs steady since a deeper-than-expected 50 basis point cut in April, and has repeatedly called on the government to do its part by improving its fiscal position, which had fuelled some expectation that it might cut rates as a gesture in reply to the government's moves.
 
Thursday's diesel price hike had initially prompted market participants to speculate that the RBI may lower interest rates on Monday, but a spike in August inflation data on Friday from July's near three-year low put a damper on such expectations.
 
India's wholesale price index rose a higher-than-expected 7.55 per cent in August from a year earlier, mainly driven by higher food prices.
 
Serious About Reform
The diesel price rise will aggravate short term inflation. But, along with the measures unveiled Friday to liberalise ownership of supermarkets and other industries, it shows the government is serious about fiscal consolidation and encouraging investment, and may make RBI Governor Duvvuri Subbarao more inclined to ease monetary policy sooner than later.
 
The government kicked into gear late last week after a wave of corruption scandals had weakened it and led to months of little substantive policy action, souring investor sentiment and putting at risk India's investment-grade credit rating.
 
Analysts have cut their economic growth forecast for the current fiscal year - some to as low as 5.1 per cent - amid stalling industrial and manufacturing activity and concerns about the current account and fiscal deficits and lack of reforms. By comparison, the prime minister's economic advisory panel's trimmed-down forecast of 6.7 per cent looks optimistic.
 
Meanwhile, the US Federal Reserve's aggressive stimulus plan last week complicates the RBI's task, as the injection of liquidity delivered by the Fed's measures may push up global commodity prices and add to inflationary pressures in India.
 
(Reuters)