The Reserve Bank today kept interest rates unchanged giving priority to checking inflation over growth, disappointing India Inc and retail borrowers who were expecting at least 0.25% rate cut.
It also rejected the widespread demand for reduction in Cash Reserve Ratio (CRR) to pump in more money into the banking system.
Unveiling the mid-quarter monetary policy review, RBI said, "reduction in the policy interest rate at this juncture, rather than supporting growth, could exacerbate inflationary pressure".
While the short term lending rate (repo) has been kept unchanged at 8%, the CRR, portion of deposits banks are required to park with the RBI, will be 4.75%.
The wholesale inflation was 7.55% in May. At the retail level, the Consumer Price Index (CPI) inflation for May was 10.36%.
RBI's action, according to Finance Minister Pranab Mukherjee, was influenced by the current price situation.
"(High inflation)...Might have weighed their (RBI's) decision making process...Normally in mid-quarter review, it is not necessary for the Governor to consult the Minister," he said in New Delhi after the policy announcement.
Mukherjee had said on Saturday that he was expecting the RBI to "adjust" the monetary policy to fuel growth.
Stock markets, which opened with gains in the morning on rate cut hopes and on positive developments in Greece, reacted negatively. The BSE Sensex fell sharply by over 200 points after the policy announcement.
Assocham President Rajkumar Dhoot said, "We are disappointed that RBI ignored all expectations, including observations of the Finance Minister about the need for a rate cut."
Chairman of Prime Minister's Economic Advisory Council (PMEAC) C Rangarajan said RBI has probably decided to wait for more time before taking policy action.
"Perhaps the RBI wants to wait for some more time...The end of the quarter may be the appropriate time to make some decision," he said, adding that the central bank might take some steps at the next policy review.
"I would think that six weeks from now, when the next review takes place...That would be the critical point...When policy decision would be clear," Rangarajan said.
The only important decision that RBI announced in its mid-quarter review was to provide some help to exporters. It raised the export refinance credit limit from 15% to 50% with a view to releasing additional liquidity of about Rs 30,000 crore, equivalent to about 0.5% of reduction in the CRR.
The decision, RBI said, would augment liquidity and encourage banks to increase credit flow to the export sector.
Countering the argument that high interest rate has been the reason behind the record dip in growth, RBI said the real effective bank lending rates are still lower than the high growth period of 2003-2008.
"This suggests that factors other than interest rates are the contributing more significantly to the growth slowdown," RBI added.
The cautious stance comes at a time when pressure has been mounting on the Mint Road mandarins to do something to revive the sagging growth and boost sentiment, which dipped to a nine-year low of 5.3% for three months ending March.
The GDP growth for the fiscal 2011-12 also plunged to 6.5%, lower than the 6.7% reported during the peak of post-Lehman collapse credit crisis.
Bankers, led by the country's largest lender State Bankof India, were rooting for a cut in CRR saying it will help in quicker transmission while a slew of think-tanks and analysts were expecting a 0.25% cut in repo rates, given the dismal growth data.
Commenting on the RBI status quo on rates, CII Director General Chandrajit Banerjee said, "Inflation is going up because of supply-side issues. We are extremely disappointed (over unchanged rates)."
Keeping in view the current industrial and economic scenario, he said, "the RBI should immediately cut interest rates by 1%".
Ficci Secretary General Rajiv Kumar said RBI could have helped in increasing investments by reducing rates.
In its guidance, RBI said future policy actions would be guided by the evolving growth-inflation dynamics, with an eye on the external and domestic development that contribute to lowering inflation risks. The next policy review will be announced on July 31.
RBI said management of liquidity is a key concern and it will continue buy government bonds. On the rupee fall, it said this should make the country's exports competitive overtime and act as a demand stimulus.
The political inability to pass on elevated crude prices to consumers is resulting in a widening of the current account deficit, and will end up crowding out investment at a time when encouraging investment is imperative from the growth perspective, RBI said.
On the troublesome economic situation globally, it said the evolution of the euro-zone crisis which has a bearing on the capital inflows, will be a factor to look out for.
Between March 2010 and October 2011, RBI had cut repo rates a record 13 times, by 350 basis points, in its battle against inflation.
After a gap of three years, on April 17, 2012, RBI had slashed short term lending rate by 0.50% to 8%. It had indicated then that its space to cut rates further was difficult.