The Reserve Bank of India surprised the markets again by pressing the pause button. Two months ago, it had delivered a higher than expected 50 basis points cut in repo rate.
This time around the RBI kept the rates pat despite calls from trade and industry and the Finance Ministry to further lower interest rates to spur flagging growth.
Industry bodies Confederation of Indian Industry (CII) and Federation of Indian Chambers of Commerce and Industry (FICCI) expressed their disappointment at the RBI's monetary policy stance.
With rate cut expectations not materialising in the RBI's mid-quarter monetary policy review, the benchmark BSE Sensex closed 1.4 per cent (or 244 points) down at 16,706 compared to the previous close. The fall in the index was led by banking and realty stocks.
Since the central bank kept its policy rates unchanged – repo rate at 8 per cent and cash reserve ratio (a portion of deposits that banks have to park with RBI) at 4.75 per cent – banks are likely to maintain a status quo on deposit and lending rates.
“Inflation continues to be high even as growth has slowed. Under the circumstances, the RBI has struck a fine balance to address both these concerns by keeping policy rates unchanged and providing banks liquidity enhancement in the form of export credit refinance,” said Mr M.D. Mallya, Chairman and Managing Director, Bank of Baroda.
Mr Mallya added that since his bank had cut both deposit and lending rates in April, it will now adopt a wait-and-watch approach.
Liquidity enhancement
Even as it held interest rates steady, the RBI announced an important measure to augment liquidity and encourage banks to increase credit flow to the export sector. It has increased the limit of export credit refinance (ECR) from 15 per cent of banks' outstanding export credit to 50 per cent,
The higher ECR limit will potentially release additionally liquidity of over Rs 30,000 crore, equivalent to about 50 basis points reduction in the CRR.
Status quo
The RBI reasoned that further reduction in the policy interest rate at this juncture could exacerbate inflationary pressures. Factors other than interest rates are contributing more significantly to the growth and investment slowdown.
The central bank observed that it had frontloaded the policy rate reduction in April with a cut of 50 basis points. This decision was based on the premise that the process of fiscal consolidation, critical for inflation management, would get under way, along with other supply-side initiatives.
Challenges
The economy is facing challenges on the growth-inflation front. GDP growth has moderated to a nine-year low of 5.3 per cent in the January-March 2012 period; the index of industrial production increased by just 0.1 per cent in April; and wholesale price index inflation has inched up from 7.2 per cent in April to 7.6 per cent in May, driven mainly by food and fuel prices.
While growth in 2011-12 has moderated significantly, headline inflation remains above levels consistent with sustainable growth. Importantly, retail inflation is also on an uptrend, said the RBI.
According to Ms Brinda Jagirdar, General Manager (Economic Research), SBI, State Bank of India, “The status quo on policy rates, though surprising, is for the good. Besides growth and inflation, the RBI has to take into account the uncertainties emanating from the Euro Zone, and the outcome of the Federal Open Markets Committee and G20 meetings over the next few days.
“Further, UK and the European Central Bank may announce Long-Term Refinancing Operations. Hence, the RBI may be waiting for more clarity on the external front.”