The Reserve Bank of India, RBI, further reduced the Cash Reserve Ratio by 100 basis points, Friday, following the 50 basis points cut announced on Monday. The emergency measure was taken to inject much needed liquidity in the domestic money markets, even as the global environment rapidly deteriorated. The cut, which will take effect from October 11, is the first reduction in CRR in at least five years. The bold stroke would inject Rs. 60,000 crores or $12.2 billion into the system.
The swift action by the central bank came as money markets were starved of liquidity, with overnight interest rates nearly doubling. This had an adverse impact on the stock markets and the Bombay Stock Exchange Sensex crashed 800 points, further hammered down by the carnage in global stock markets.
Seeking to reassure the markets, the RBI said that India's macroeconomic fundamentals were sound in the face of the challenging global financial environment. India's financial system was strong, resilient, well capitalized and well regulated, the central bank observed. The money markets and forex markets were functioning in a relatively orderly fashion. However, the global situation had worsened further and international stock markets and money markets had been significantly affected, the Reserve Bank said.
The RBI was closely and continuously monitoring the situation and would respond swiftly and even preemptively to any adverse external developments impinging on domestic financial stability, price stability and inflation expectations and the continuation of the growth momentum of the Indian economy, the central bank said. The main thrust of policy was to maintain price stability, according to the RBI.
Annual rate of inflation declined to 11.80% for the week ending September 27 2008, from the 11.99% witnessed in the previous week. Inflation was 3.36% in the same year-ago period. Inflation in prices of 30 essential commodities increased 7.74%, slightly more than the 7.70% gain posted in the prior week. Prices of primary articles rose 11.17%, while prices of fuel and power surged 16.52% and prices of manufactured products climbed 10.33%.
However, the RBI had to wake up to the reality of slowing growth, economists said. The Index of Industrial Production rose an anemic 1.3% on an annual basis in August, compared to the robust 10.7% in the same period of the previous year. The index of Industrial Production for Mining increased 4.0% in August 2008, compared to the 17.1% in the previous year. Manufacturing edged up 1.1% in August, a steep drop from the 10.3% growth posted in the same year-ago period. The index for Electricity grew 0.8% much lower than the 8.3% surge witnessed in August of the previous year. Overall, the index for Industrial Production advanced 4.9% for the April -August period, decelerating from the solid 9.8% growth achieved in the same period of the previous year.
With inflation weakening, the government and the RBI had to focus on maintaining growth, analysts observed. This would warrant an interest rate cut, they said. Policy makers should maintain liquidity, but at affordable costs, they pointed out. Otherwise growth in general, and infrastructure growth in particular, which require large capital outlays, would suffer, they added.
However the government appeared to be satisfied with the steps the RBI had initiated. "We have identified that the main problem is liquidity, and we have assured the people that we will respond swiftly and take steps to infuse more liquidity according to the needs of the situation," said the Finance Minister Palaniappan Chidambaram. The World Bank had also said that India was in a relatively better position to weather the global financial turmoil, he pointed out. Further, the Minister had constituted a group headed by the Finance Secretary to study liquidity problems and report back in a week's time. "The fundamentals of our economy are strong and there are many indicators which affirm the sound fundamentals," the Finance Minster noted.
Yet, the outlook for India was negative due to the high potential for loan defaults to increase in the near term, as well as the inadequate credit risk assessment capabilities and banking practices, the Global Insight said. Analysts are also worried that the government was in a denial mode in dealing with the crisis and urged urgent action to de-freeze money markets while slashing interest rates to promote and maintain the growth momentum.
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