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RBI keeps rates steady; Re wipes out recent gains,dips 1.76%

Central bank lowers GDP growth projection for current fiscal to 5.5% from 5.7%

Written by ENS Economic Bureau | Mumbai | Published: July 31, 2013 1:36 am

The Reserve Bank of India (RBI) struck a dovish tone on Tuesday,choosing to leave interest rates unchanged at its first policy review this fiscal,even as the rupee reacted by nosediving 1.8 per cent against the dollar in its biggest crash in more than a month.

The weakening of the rupee below the psychological mark of 60 to a dollar came as banks adjusted their positions on the expectation that the central bank has limited room now to defend the rupee from falling further. The fall was precipitated by the RBI Governor Duvvuri Subbarao’s comments that the central bank has reservations on issuing sovereign bonds.

The rupee closed at 60.49 per dollar,down 1.76 per cent from the previous close of 59.42. With this,the currency has given up the gains since the RBI’s rescue measures announced on July 15. The benchmark BSE Sensex reacted by falling 244 points or 1.25 per cent while the broader Nifty fell by 76 points or 1.3 per cent.

As expected,Subbarao left the policy repo rate unchanged at 7.25 per cent and held banks’ cash reserve ratio at a record low 4 per cent,but said the central bank will roll back the recent liquidity tightening measures when “stability returns to the currency market”. Subbarao,while delivering the final monetary policy statement of his tenure that comes to an end on September 4,indicated that in its order of priorities,the RBI has accorded the highest importance to addressing the risks to macroeconomic stability from external shocks,especially a possible winding down of loose US monetary policy. What has dropped lower down the list are concerns about slowing growth and inflation that could rise because of depreciation of the rupee.

“Most external vulnerability indicators have deteriorated,eroding the economy’s resilience to shocks,” Subbarao said.

Immediately after the RBI’s policy review announcement,the chief economic adviser to the finance ministry Raghuram Rajan said at a news briefing that the government will announce measures to help narrow the current account deficit in the next few weeks,including possible ways of bringing in foreign investments.

In its review,the RBI cut its GDP growth forecast to 5.5 per cent from 5.7 per cent for the current fiscal year. Subbarao said that,had the currency been stable,the growth and inflation balance would have allowed for sticking with a monetary easing stance. The RBI,meanwhile,lowered its inflation forecasts from 5.5 per cent to 5 per cent for March 2014.

“India is currently caught in a classic ‘impossible trinity’ trilemma whereby we are having to forfeit some monetary policy discretion to address external sector concerns,” Subbarao said.

Meanwhile,bankers,who ruled out raising lending rates in the near future,said they will review the situation in the next two or three weeks. “We are waiting because these steps are supposed to be temporary. So,unless the RBI lingers on for very long,none of the banks are increasing their loan pricing. Loan demand is too weak,” SBI chairman Pratip Chaudhuri said. SBI would review the situation after two or three weeks,he said. “Given the developments in the external sector,monetary policy is currently focused on addressing risks to macroeconomic stability from external shocks. The guidance that these measures will be rolled back in a calibrated manner as the foreign exchange market stabilises is welcome,” ICICI Bank MD Chanda Kochhar said.

RISK warnings

* The biggest risk to the macroeconomic outlook stems from the external sector. Financial markets around the world went into a flash turmoil on the perception of an earlier than expected tapering of QE by the US Federal Reserve. The rupee depreciated in nominal terms by 5.8 per cent between May 22 and July 26 in the wake of capital outflows.

* The large CAD,well above the sustainable level of 2.5 per cent of GDP for three years in a row,is a formidable structural risk factor. It has brought the external payments situation under increased stress,reflecting rising external debt and the burden of servicing of external liabilities.

* The investment climate remains weak and risk aversion continues to stall investment plans. The outlook for investment is inhibited by cost and time overruns,high leverage,deteriorating cash flows,erosion of asset quality and muted credit confidence.

* An environment of low and stable inflation and well-anchored inflation expectations is necessary to sustain growth in the medium-term. The pressures from wage increases and upward revisions in administered prices could weaken growth further and exacerbate inflation pressures.

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