In its policy statement for the financial year 2013/14, which began on April 1, the Reserve Bank of India (RBI) cautioned that recent rate cuts cannot by itself revive economic growth and its moves to stimulate growth need to be supplemented by efforts towards easing supply bottlenecks, improving governance and stepping up public investment along with continuing commitment to fiscal consolidation.
The RBI has now cut rates three times this year by a total of 75 basis points after cuts of 50 basis points in 2012, and said its policy stance for 2013/14 was guided by its expectation that economic activity will remain subdued in the first half of the current year with a modest pick-up in the second half of the year.
However, although headline wholesale price inflation eased in March, the RBI said “food price pressures persist and supply constraints are endemic, which could lead to a generalization of inflation and strains on the balance of payments.”
“Monetary policy will also have to remain alert to the risks on account of the CAD (Current Account Deficit) and its financing, which could warrant a swift reversal of the policy stance,” the RBI said, adding: “Overall, the balance of risks stemming from the Reserve Bank’s assessment of the growth-inflation dynamic yields little space for further monetary easing.”
India’s main inflation gauge, the wholesale price index, rose 5.96 percent in March, down from 6.84 percent in February, continuing its gradual decline form a recent high of 10 percent in September 2011, and the lowest inflation rate since November 2009.
However, the RBI said upside risks to near-term inflation were significant due to “sectoral demand supply imbalances,” corrections to administered prices and pressures from minimum support price increases so “monetary policy cannot afford to lower its guard against the possibility of resurgence of inflation pressures.”
India’s economic growth slowed to a decade low of 5 percent in the 2012/13 financial year. In the fourth quarter of the 2012 calendar year – the equivalent of the third quarter of the fiscal year – Gross Domestic Product expanded by 1.3 percent for annual growth of 4.5 percent, down from 5.3 percent in the third quarter, and well below growth rates of over 9 percent in early 2010.
In addition to the cut in the repo rate, the RBI said the reverse repo rate, which is set with a spread of 100 basis points below the repo rate, would be adjusted to 6.25 percent while the marginal standing facility rate, with is set 100 basis points above the repo rate, would be set at 8.25 percent.
The Bank Rate would be set at 8.25 percent while the cash reserve ratio (CRR), which some economists had expected could be cut, was retained at 4.0 percent. The CRR – the proportion of deposits that banks have to keep in cash at the RBI – was cut by 25 bps in January to its current level.
The drop in inflation in March had boosted hopes for a rate cut along with statements by the RBI’s chief economic advisor, Raghuram Rajan, who said there was scope for interest rate cut as inflation has come down and there is a need to push growth.
In its review of macroeconomic and monetary developments in 2012/13, which ended March 30,
the RBI had already said the room to cut interest rates further was very limited in light of “headline inflation remaining above the threshold and consumer price inflation remaining high.”
The review, which was released yesterday as a backdrop to the RBI’s rate-setting meeting, also said headline inflation was likely to remain range-bound in 2013/14 with some moderation in the first half due to subdued pricing power by producers and falling global commodity prices before rising in the second half due to base effects.
The RBI’s own survey of forecasters shows growth recovering in 2013/14 to 6.0 percent from 5.0 percent in 2012/13 and average WPI inflation easing to 6.5 percent from 7.3 percent.
India’s current account deficit is “by far the biggest risk to the economy” the RBI said.
The current account deficit is likely to ease in the fourth quarter of the 2012/13 financial year due to lower imports and a pick up in exports after a record high of 6.7 percent of GDP in the third quarter. For the full year, the deficit is expected to be around 5.0 percent of GDP, “twice the sustainable level,” the RBI said in its economic review.
India is one of the few countries worldwide to suffer from inflationary pressure during the current phase of weak economic growth. In 2012 inflation slowed markedly across much of Asia, except for India , Indonesia, and to a lesser extent Thailand, according to the International Monetary Fund’s latest regional outlook.
The IMF forecasts India’s inflation to be the second highest in Asia this year, only surpassed by Mongolia. Even Vietnam, which has been struggling with inflation, is forecast to cut inflation this year to 8.8 percent from 2012’s 9.1 percent.
Measured by consumer prices, India’s inflation rate is expected to average 10.8 percent this year, up from 9.3 percent in 2012, and then hit 10.7 percent in 2014.
“Inflation is expected to remain generally within central banks’ explicit or implicit comfort zones, with the notable exception of India,” the IMF said.
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