RBI refuses to play ball,keeps rates unchanged

Maintaining the repo rate (the rate at which the RBI lends funds) and cash reserve ratio (the portion of bank deposits kept with RBI) at current levels of 8 per cent and 4.75 per cent respectively,RBI said the “persistence of overall inflation both at the wholesale and retail levels,in the face of significant growth slowdown,points to serious supply bottlenecks and sticky inflation expectations”.

Despite not cutting CRR,the RBI has increased the limit of export credit refinance from 15 per cent of outstanding export credit of banks to 50 per cent,which will potentially release additional liquidity of over Rs 30,000 crore,equivalent to about 50 basis points reduction in CRR.

While cutting repo rate by a sharp 50 basis points on April 17 during the annual review of monetary policy,RBI Governor D Subbarao had lobbed the ball in the government’s court before it could further ease its stance. “If subsidies are not contained as indicated in the union budget last month,demand pressures will persist,and will further reduce whatever space there is for monetary easing,” he had said.

It has been two months since then,but the government has not been able to muster the courage to raise diesel,kerosene and LPG prices.

On Monday,the RBI did not blink in blaming the government for sluggish investment. “The subsidy burden on the government is crowding out public investment at a time when reviving investment,both public and private,is a critical imperative,” it said in a statement. The widening current account deficit (CAD),despite the slowdown in growth,is symptomatic of demand-supply imbalances and a pointer to the urgent need to resolve the supply bottlenecks,it said.

Finance Minister Pranab Mukherjee said high inflation numbers “might have weighed on their (RBI’s) decision-making process. And normally in mid-quarter review,it is not necessary for the governor to consult the minister”. On Saturday,Mukherjee had said,“I’m confident the RBI will adjust the monetary policy as we are adjusting fiscal policy.”

The RBI had frontloaded the policy rate reduction in April with a cut of 50 basis points — after raising rates 13 times since March 2010 to tackle inflation — based on the premise that the process of fiscal consolidation critical for inflation management would get under way,along with other supply-side initiatives. Subbarao had then said a future rate cut would hinge on a decline in inflation.

Rejecting the argument that high interest rates are affecting economic growth,the RBI said,“Estimates suggest that real effective bank lending interest rates,though positive,remain comparatively lower than the levels seen during the high growth phase of 2003-08. This suggests that factors other than interest rates are contributing more significantly to the growth slowdown.”

In its “assessment of the current growth-inflation dynamic,there are several factors responsible for the slowdown in activity,particularly in investment,with the role of interest rates being relatively small,it said.

In its guidance,the RBI said future actions would depend on a continuing assessment of external and domestic developments that contribute to lowering inflation risks. Though core inflation has moderated,reflecting demand conditions and lower pricing power,both headline and retail inflation rates are rising,which have a bearing on inflation expectations.

On management of liquidity “which remains a priority”,it said “even as the liquidity situation converges to the comfort zone,the RBI will continue to use open market operations (OMOs) as and when warranted to contain liquidity pressures”. The widening wedge between deposit growth and credit growth is intensifying liquidity pressures.

According to the RBI,since its annual policy statement in April,global macroeconomic and financial conditions have deteriorated. At the same time,the domestic macroeconomic situation too raises several deepening concerns. 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. WPI inflation inched up from 7.2 per cent in April to 7.6 per cent in May. In the absence of pass-through from international crude oil prices to domestic prices,the consumption of petroleum products remains strong distorting price signals and preventing the much needed adjustment in aggregate demand,it said.

On the eurozone issue,it said,“should there be an event shock,central banks in advanced economies will likely do another round of quantitative easing. This will have an adverse impact on growth and inflation in emerging economies,particularly on oil importing countries such as India,through a possible rebound in commodity prices.”