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India's Central Bank Maintains Status Quo

RBI-Raghuram-Rajan-121713.jpg

India's central bank unexpectedly adopted a "wait and watch" stance on Wednesday as it assessed merit in waiting for more data, but vowed to take calibrated actions in future.

Despite seeing a sharp acceleration in inflation, the Reserve Bank of India decided to leave its key repo rate unchanged at 7.75 percent on Wednesday.

The repo rate is the rate at which the RBI lends to banks. The bank was widely expected to hike its rate by 25 basis points.

The RBI maintained the reverse repo, the rate at which the bank accepts deposits from banks, at 6.75 percent. The cash reserve ratio was also retained, at 4.00 percent.

The marginal standing facility, that was introduced to halt a slump in the rupee was also kept intact. The MSF rate was retained at 8.75 percent.

Governor Raghuram Rajan has raised the key interest rates twice this year after taking the helm at the central bank in September. It will take more time for previous rate hikes to take effect, Rajan said today.

The central bank chief added that the bank will not react to each inflation figure. He expects food price inflation to ease on the back of good monsoon.

"The policy decision is a close one," Rajan said in the mid-quarter monetary policy review.

"Given the wide bands of uncertainty surrounding the short term path of inflation from its high current levels, and given the weak state of the economy...there is merit in waiting for more data to reduce uncertainty."

According to the RBI, there are obvious risks to pausing that include the possibility that tapering of quantitative easing by the U.S. Fed may disrupt external markets and that the Reserve Bank may be perceived to be soft on inflation.

The bank said it will act, including on off-policy dates if warranted, so that inflation expectations stabilize and an environment conducive to sustainable growth takes hold. The Reserve Bank's policy action on those dates will be appropriately calibrated, it said.

The bank will act if food prices do not soften in months ahead and reduce the overall inflation, Rajan told reporters.

Inflation based on the wholesale price index, rose to 7.52 percent in November, a 14-month high, from October's 7 percent.

At the same time, consumer price inflation hit a record 11.24 percent in November, up from 10.17 percent the prior month. Today, the RBI said current inflation is too high.

Given that the economic recovery still very fragile, Daniel Martin, an economist at Capital Economics said the RBI will be patient with inflation. As long as it starts to come down at the start of next year, more rate hikes are unlikely, he noted.

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