Central bank cuts repo rate by 25 bps, CRR unchanged

In keeping with expectations, the Reserve Bank of India (RBI) on Friday cut the repo rate by 25 basis points to 7.25 but kept the cash reserve ratio (CRR) unchanged at 4.0 per  cent stating that the policy stance for 2013-14 has been guided by two considerations against the backdrop of global and domestic macroeconomic conditions, outlook and risks.

Repo is the rate at which banks borrow from the central bank, while CRR is the portion of total deposits banks are mandated to park it with the RBI bereft of interest. Consequently, the reverse repo or the rate at which banks park excess liquidity with the RBI stands at 6.25 per cent. 

However, the RBI warned that the risk of inflationary pressure persists despite a recent sharp decline in the wholesale price index (WPI) inflation, and said a high current account deficit poses the biggest risk by far to the Indian economy.  “The balance of risks stemming from the Reserve Bank’s assessment of the growth-inflation dynamic yields little space for further monetary easing,” the RBI wrote in its policy statement.

RBI Governor Duvvuri Subbarao on Friday made it clear that there is little room to ease monetary policy further, which disappointed markets that had hoped for more aggressive policy easing action, which led to BSE Sensex closing with a loss of 160 points.

He pointed out that the country grapples with economic growth that slowed to about 5 per cent in the fiscal year that ended in March, its weakest in a decade. Apart from equities, the rupee fell and bond yields rose after the policy statement.
India's headline inflation in March fell to its lowest in more than three years at 5.96 per cent, but the consumer price index remained elevated at 10.39 per cent.

At the post-policy media briefing here, Subbarao described the high current account deficit (CAD) as the biggest risk to Indian economy which last year was historically the highest saying, “monetary policy will also have to remain alert to the risks on account of CAD and its financing, which could warrant a swift reversal of the policy stance.”

CAD, which is the difference between the inflow and outflow of foreign currency, had touched a record high of 6.7 per cent in the December quarter of last fiscal year. The CAD in 2012-13 fiscal is likely to be around 5 per cent of the gross domestic product (GDP).

While it is expected to ease on lower global commodity prices and a rise in exports, it is on track to remain well above the 2.5 per cent level that is seen as sustainable. The RBI said it expects the economy to grow at 5.7 per cent in the fiscal year that started in April, and projected headline WPI inflation at around 5.5 per cent during the year, while its intention is to lower WPI inflation to 5 per cent by March 2014 “using all instruments at its command.”

Even as the large CAD is a risk by itself, its financing exposes the economy to the risk of sudden stop and reversal of capital flows, should global liquidity rapidly tighten, it added.

If global liquidity conditions rapidly tighten, India could potentially face a problem of sudden stop and reversal of capital flows, jeopardising our macro-financial stability, the apex bank said. It also noted that a large CAD, appreciably above the sustainable level, year after year, will put pressure on servicing of external liabilities.
The RBI said sustained revival of growth is not possible without a revival of investment. So, it has once again urged the government to take measures to ease supply constraints in the economy and encourage investment.