RBI hints interest rates will not change

The Reserve Bank of India (RBI) on Monday made it clear that its focus will continue on managing money market liquidity in order to balance financial stability, growth and inflation.

Going by the document of the Macroeconomic and Monetary Developments First Quarter Review 2013-14 released on Monday — which serves as a backdrop to the First Quarter Review of Monetary Policy Statement 2013-14 to be announced on July 30, 2013 — RBI gave no indication of any rate cut in the policy review meet to be held on Tuesday nor in the near future.

Although RBI took a slew of measures to support the weakened rupee, its policy focus has now shifted from reviving economic growth to defending the rupee that hit a record low of 61.21 to the dollar on July 8, when it was down more than 9 per cent since the start of the year. “Global currency market movements in June-July 2013 have prompted a recalibration of monetary policy,” said RBI in its a macroeconomic report, a day prior to leaving interest rates probably unchanged at its monetary policy review.

“The priority for monetary policy now is to restore stability in the currency market so that macro-financial conditions remain supportive of growth,” it added.

Further, the RBI has squeezed liquidity from the money market and pushed up short-term interest rates in order to deter capital outflows, allowing the rupee to make a slight recovery, and by late Monday it was trading around 59.40 to the dollar. “The RBI will endeavour to actively manage liquidity to reinforce monetary transmission that is consistent with the growth-inflation balance and macro-financial stability,” it said.

It may be noted that RBI last cut its policy repo rate by 25 basis points to 7.25 per cent in May and it left the rate on hold at its last review, in June. The banking regulator reiterated its call for the government to implement measures to attract stable capital flows, saying that recent central bank steps to stem volatility in the rupee “provide at best some breathing time”. In the report, the RBI’s survey of professional forecasters lowered its growth forecast for the fiscal year that started in April to 5.7 per cent from 6 per cent in its previous survey.

It also foresaw a current account deficit of 4.4 per cent of gross domestic product for the current fiscal year, compared with a deficit of around $88 billion, or a record 4.8 per cent of GDP, in the last fiscal year.

The survey projected wholesale price index inflation at 5.3 per cent during the current fiscal year, lower than the 6.5 per cent forecast in its last survey.

The headline wholesale price inflation picked up for the first time in four months in June to 4.86 per cent annually, while the consumer price index also remained elevated at 9.87 per cent, a key worry for the RBI.

Even though the current account deficit (CAD) to GDP ratio moderated to 3.8 per cent in Q4 of 2012-13 from its historic high of 6.5 per cent in Q3 of 2012-13, indications are that it may have widened again in Q1 of 2013-14. Trade deficit has widened in Q1 of 2013-14 on account of contraction in exports and sharp increase in gold imports.

Going forward, the current account is expected to show improvement. The demand for gold is likely to decline with increase in customs duty and rationalisation of gold import policy. While CAD may fall in 2013-14, risks to CAD financing have increased with firming up of US yields that caused global bond sell-off and capital outflows from EMDEs, including India.

Vulnerability indicators of the external sector have deteriorated. Short-term debt (residual maturity) constituted 44 per cent of the total debt at end-March 2013. India’s net international investment position was (-)16.7 per cent of GDP.

In this milieu, RBI said, structural policy reforms are needed to reduce CAD and to improve its financing by attracting more stable capital flows to the Indian economy.