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India Retains Key Rates, Trims Reserve Ratio By 25 Bps

India Retains Key Rates, Trims Reserve Ratio By 25 Bps

India's central bank on Monday retained its key interest rate as expected citing inflation fears, while policymakers unexpectedly reduced the amount that banks should set aside as reserves.

The Reserve Bank of India (RBI) left the repo rate unchanged at 8 percent and the reverse repo at 7 percent in its mid-quarter review today. The repo rate is the rate at which the central bank lends to banks and the reverse repo rate is the rate at which it accepts deposits from banks.

The previous change in the key rates was in April, when the rates were slashed by 50 basis points. That front-loaded reduction was based on expectations of fiscal policy support for inflation management, but it failed to materialize, the bank said today.

Further, the bank said the primary focus of monetary policy remains the containment of inflation and anchoring of inflation expectations.

In a bid to improve liquidity, Governor Duvvuri Subbarao reduced the cash reserve ratio to 4.50 percent from 4.75 percent. The bank earlier reduced the ratio in January and March this year. The latest reduction is expected to inject INR 170 billion into the banking system.

Regarding price pressures, the RBI said the headline wholesale price inflation has remained sticky at around 7.5 percent throughout the current financial year so far.

Despite strong opposition, the government last week raised diesel prices by about 14 percent and limited the supply of subsidized cooking gas for each buyer adding to inflationary pressures. While welcoming the move, the central bank said more needs to be done.

Prime Minister Manmohan Singh also relaxed the ceiling for foreign direct investment into sector such as aviation, retail and broadcasting. The government aims to cut its budget deficit to 5.1 percent of gross domestic product through March 2013.

Amid slowing growth, the government faces difficulty in cutting its subsidies and bring the deficit to target, while persistently high inflation and weak currency are adding to the dilemma of the central bank.

The RBI observed that there will be pressures on headline inflation in the short-term from the recent upward revision in diesel prices and rationalisation of cooking gas subsidy. However, it will strengthen macroeconomic fundamentals over the medium-term.

"In the current situation, persistent inflationary pressures alongside risks emerging from twin deficits - current account deficit and fiscal deficit - constrain a stronger response of monetary policy to growth risks," the bank said in a statement.

"Accordingly, as this process evolves, the stance of monetary policy will be conditioned by careful and continuous monitoring of the evolving growth-inflation dynamic, management of liquidity conditions to ensure adequate flows of credit to productive sectors and appropriate responses to shocks emanating from external developments," it said.

The Indian economy expanded 5.5 percent in the June quarter, after a 5.3 percent expansion in the preceding three months. The central bank expects 6.5 percent growth for 2012-13. The RBI's estimate is too optimistic compared to the forecast of banks and brokerage firms.

Citigroup and CLSA downgraded their view of the country's growth for the current fiscal year to 5.4 percent and 5.5 percent, respectively. Morgan Stanley cut its growth forecast for the fiscal year ending March 2013 to 5.1 percent from 5.8 percent, citing weak external demand as well as low private investment.

by RTT Staff Writer

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