RBI takes a pricey call on growth, goes for a token rate cut of 25 bps

MUMBAI: The high probability of a resurgence in inflationary pressures overshadowed concern over anaemic economic growth, making the Reserve Bank of India governor limit his action to a token interest rate cut while making it clear that the prospects of further cuts were limited. The governor said the onus of reviving industrial activity rested with the government while reiterating that easy monetary policy alone could not revive investments. Further, the record current account deficit — the excess of overseas consumption over earnings — and supply-side bottlenecks might keep a lid on interest rate easing.

Sitting a few paces away from where Governor Duvvuri Subbarao announced his monetary policy actions, bank chairmen declared that there was little scope for lowering borrowing costs for companies and individuals. “There is no scope to cut rates,” said Pratip Chaudhuri, chairman, State Bank of India. “There is no compulsion on us to cut rates. In fact, there is nothing to transmit.”

Subbarao lowered the repo rate — the rate at which the central bank lends to banks — 25 basis points to 7.25% as expected. Bank rate and reverse repo — the rate RBI pays banks for keeping excess funds with it — will fall proportionately. Cash reserve requirement — the proportion of bank deposits to be kept with RBI — was unchanged at 4%, disappointing bankers.

Price pressures will resurface as and when the government raises the prices of coal, power and even diesel to market levels, which makes it difficult to conclude that inflation has settled at a lower level permanently, said Subbarao.

“According to current estimates, the scope for more easing is very limited,” he said. “Monetary policy will also have to remain alert to the risks on account of CAD (current account deficit) and its financing, which could warrant aswift reversal of the policy stance.”

Richard Iley, chief asia economist at BNP Paribas, said, “Managing and mitigating the risks flowing from the yawning current account deficit, which hit an all-time high of 6.7% of GDP in Q4 2012 are also a key driver as is what Governor Subbarao has termed ‘the political economy of fiscal consolidation’.”

“RBI continues to play a game of cat and mouse with the finance ministry as it seeks to encourage greater fiscal rectitude.”

The growth rate for fiscal 2013-14 is forecast at 5.7%. The first half of the year could be sluggish and most of the growth would come in the second half, according to RBI’s forecast. The Central Statistical Organisation forecast 5% growth last fiscal. Inflation is expected to be in the 5-5.5% range, lower than the 7.3% average in fiscal 2013. But the central bank said it would do everything under its control to keep it at 5% by March 2014.

“It is critical to consolidate and build upon the recent gains in containing inflation,” said Subbarao. “Accordingly, the Reserve Bank will endeavour to condition the evolution of inflation to a level of 5% by March 2014, using all instruments at its command,” he said, leading some to interpret it as a step towards inflation targeting.