The Reserve Bank of India (RBI) did not cut the repo rate and cash
reserve ratio on Monday, given the weakening of the rupee by 9 per cent since May this year. This was despite wholesale price index (WPI) inflation remaining below RBI’s comfort levels of 5 per cent for the second consecutive month in May.
Belying the hopes of India Inc and repeated calls by the finance ministry, the bank left repo rate unchanged at 7.25 per cent and the cash reserve ratio — or the share of deposits banks must keep with the central bank — at 4 per cent in its mid-quarter review. The reverse repo –the rate at which banks park surplus money with the RBI – currently stands at 6.25 per cent.
The decision was widely expected given the upside risks to inflation and the weakening of the rupee which has exposed the vulnerability of India’s current account deficit to volatile capital flows. The partially convertible rupee depreciated by 36 paise to close at 57.87/88 per dollar on Monday compared with 57.5150/5250 on Friday, its second session of fall in three. Intra-session, It fell to 57.90.
Finance Minister P Chidambaram, who appeared disappointed by the monetary policy, said, "I think the government at various levels conveyed its view to the RBI. This is a mid-term review. We recognise that the RBI is independent. There is nothing more for me to say at this stage."
Commenting on the RBI action, Prime Minister's Economic Advisory Council Chairman C Rangarajan said the decision has been influenced by external sector considerations, in particular, the widening current account deficit.
However, the industry as a whole, hoped that the RBI would not wait for the next quarterly review on July 30 to intervene, and would do so earlier if required. Industry body Assocham said that rupee depreciation and its possible impact on inflation should not be the only considerations while deciding monetary policy.
Inflationary forces
The RBI said that the rates were kept unchanged in view of high food inflation, particularly of cereals and vegetables which has put pressure on overall inflation rate.
RBI Governor D Subbarao noted in the mid-term quarterly review of monetary policy that only a “durable receding” of inflation would prompt it to lower interest rates going forward. The central bank said it would watch the distribution and intensity of rainfall over the next few months before determining how agricultural output fares.
In response to the monetary policy, Shyam Srinivasan, Managing Director and CEO of Federal Bank, said that inflation would be contained further with the monsoon progressing well and softening global commodity prices. “This is likely to lead to a situation of ‘durable receding of inflation’ and should pave the way for monetary easing in the short to medium term,” he said.
Barclays Bank said in a note to clients on Monday that most inflation indicators will remain supportive in coming months. “This will eventually open up more room for monetary easing. Accordingly, we continue to expect a further 75 basis points reduction in repo rate during the remaining months of 2013,” the bank said.
Abheek Barua, chief economist at HDFC Bank, said for a central bank managing an "economy buffeted by adverse external pressures and extreme uncertainty in the global policy environment”, the holding action by the RBI is justifiable.
The current account deficit, another prime concern for the RBI while deciding its monetary policy stance, could narrow as gold imports have shown some decline. The RBI said India remains vulnerable to a shift in global market sentiment that could trigger large withdrawals from developing countries.
A higher volume of imports have widened the current account deficit (CAD), which hit a record high of 6.7 per cent in October-December.
Even as several measures were taken to contain the current account deficit, the RBI review statement said, “We need to be vigilant about the global uncertainty, the rapid shift in risk perceptions and its impact on capital flows.” The RBI said it was ready to use all available instruments and measures to respond rapidly and appropriately to any adverse developments.
Analysts said that the persistence of food inflation signalled that government and policymakers were not addressing the reason of its rise. They feared that unless the core issues of supply-side management and distribution are handled properly, food inflation will not recede.
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