RBI monetary policy review: Rupee fear makes cbank leave interest rates unchanged

RBI has forfeited monetary policy discretion to address external sector concerns.

Written by Reuters | Mumbai | Published: July 30, 2013 11:20 am

The Reserve Bank of India (RBI) at its monetary policy review meet on Tuesday left interest rates unchanged as it sought to support a battered Indian rupee but said it will roll back recent liquidity tightening measures when stability returns to the currency market,enabling it to resume supporting growth.

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As expected,the Reserve Bank of India left its policy repo rate at 7.25 percent but took a dovish tone as it cut its growth forecast for Asia’s third-largest economy to 5.5 percent for the fiscal year,from 5.7 percent previously. It held the cash reserve ratio at 4.00 percent.

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The RBI said recent liquidity tightening steps “will be rolled back in a calibrated manner as stability is restored to the foreign exchange market,enabling monetary policy to revert to supporting growth with continuing vigil on inflation.”

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The last policy statement of RBI Governor Duvvuri Subbarao’s five-year tenure,unless it is extended,continued to call on the government to take urgent steps to bring down the current account deficit,which hit a record 4.8 percent of GDP in the last fiscal year. The current account gap makes India especially vulnerable as global investors move away from emerging markets in anticipation of a winding down of loose U.S. monetary policy.

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Turkey,Brazil and Indonesia have all raised rates to counter capital outflows. Indian policymakers will be hoping the U.S. Federal Reserve doesn’t spark a fresh surge in flows away from emerging markets when it holds its policy review this week. “It should be emphasised that the time available now should be used with alacrity to institute structural measures to bring the CAD down to sustainable levels,” Subbarao said.

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However,New Delhi has struggled to implement steps to attract foreign corporate investment,and with elections due by May,Prime Minister Manmohan Singh’s weak coalition government has limited room for pushing through further reforms. The rupee fell to a record low 61.21 to the dollar on July 8,when it was down about 10 percent since the start of 2013.

While India has succeeded in stabilising the rupee,which ended on Monday at 59.42,the surge in short-term interest rates has squeezed funding for corporate borrowers and prompted many economists to cut their growth forecasts. “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.

India grew at 5 percent in the fiscal year that ended in March,its weakest in a decade,which had prompted the RBI to cut rates by 125 basis points since last year,although it paused in June amid worries of high consumer price inflation. It said it aims to keep headline wholesale price index inflation at around 5 percent by the end of the fiscal year in March and 3 percent over the medium term. Annual wholesale inflation rose slightly to about 4.9 percent in June.


Weighed down by a weak rupee,the Reserve Bank today chose to keep all key interest rates unchanged and asked the government to take urgent steps to reign in the high current account deficit. Lowering the GDP growth projection for the current fiscal to 5.5 per cent from 5.7 per cent,the central bank said the external sector is the “biggest threat” to economic stability. It also said that the recent liquidity tightening measures,taken to support the rupee,will be rolled back in a calibrated manner as stability is restored to the foreign exchange market,enabling it to revert to the policy of supporting growth with continuing vigil on inflation. The RBI will endeavour to keep inflation,which is under threat from a depreciating rupee,at 5 per cent by March end.

“The policy stance is guided by the need for continuous vigil and preparedness to pro-actively respond to risks to the economy from external developments,especially those stemming from global financial markets,” Governor D Subbarao said in what would be his last policy announcement unveiled here. Accordingly,the repo rate or the rate at which RBI lends to the system,has been retained at 7.25 per cent and the cash reserve ratio,the amount of deposits banks park with RBI,has been kept unchanged at 4 per cent. Giving the policy guidance,the governor said “monetary policy going forward will be shaped by the consideration of supporting growth,anchoring inflation expectations and maintaining external sector stability.”

Subbarao,who is slated to retire days before the next mid-quarter review on September 18,said the policy stance is aimed at addressing risks to macroeconomic stability and growth and guard against the re-emergence of inflationary pressure. It would also endeavour to manage liquidity conditions to ensure adequate credit flow to productive sectors of the economy. The current situation of low headline inflation,prospects of softening food inflation on a good monsoon and decelerating growth warranted a pro-growth policy stance,but for the difficulties on the external front,as reflected in the almost 10 per cent depreciation in the rupee and the rising current account deficit,he said.

Stating that the external sector was the “biggest risk to macroeconomic stability,” Subbarao called for urgent policy steps from the government to curtail the CAD to a sustainable level of 2.5 per cent of GDP and said that the RBI is ready to use all instruments under its command help in the efforts. “It should be emphasised that the time available now should be used with alacrity to institute structural measures to bring CAD down to sustainable levels,” the Governor said.

The recent liquidity tightening measures,brought in to reduce speculative pressures on the rupee,which had hit a record low of 61.21 to the dollar on July 8,will be rolled back once the currency stabilises,which will lead to a shift in the monetary policy to be more accommodative and pro-growth,he added. The benchmark S&P BSE Sensex opened higher and remained flat soon after the unveiling of the policy,which was along expected lines.


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