RBI pauses, but signals rate cut

Growth risks in focus, status quo upsets India Inc.

In October this year, Reserve Bank of India Governor D Subbarao had said “further rate hikes might not be warranted”. Two months later, he has kept his promise by keeping policy rates unchanged for the first time in 12 months despite high inflation.

In fact, the language in the mid-quarter review of the monetary policy released on Friday has changed significantly, with RBI clearly signalling a reversal of the rate hike cycle. “From this point on, monetary policy actions are likely to reverse the cycle, responding to the risks to growth in the process,” an RBI statement said.

This is despite the fact that “inflation risks remained high and a slump in the rupee was also exerting price pressures”.

The central bank kept the repo rate, at which it lends to banks, steady at 8.5 per cent in its mid-quarter monetary policy review. RBI had increased the repo rate by 225 basis points in seven tranches since December 2010 to tame rising inflation.

RBI made it clear that it would deal with the current liquidity squeeze through more open market operations (OMOs) and left the cash reserve ratio (CRR) unaltered at six per cent.

Bankers were relieved. Terming it a “turning point in monetary policy”, Chanda Kochhar, Managing Director and Chief Executive Officer of ICICI Bank, said RBI had addressed the concerns on the interest rate side by clearly indicating a likely reversal in the cycle.

But corporate India isn’t impressed with the status quo. Rajeev Talwar, Group Executive Director of DLF, the country’s largest real estate firm, said, “RBI is becoming extra cautious when there is gloom, despondency and pessimism. Even when the finance minister is nudging him to support growth, the Governor has not taken that path yet. It will not help any industry.”

“I am disappointed with the monetary policy. It would have been nice had RBI cut the CRR and policy rates. That would have given a boost to the economy,” Adi Godrej, Chairman of Godrej Group, said.

The stock market also reflected this dampened spirit as benchmark indices ended the day 2-2.2 per cent below yesterday’s close.

A large section of economists and bankers feel RBI will take time in actually reducing policy rates. According to Diwakar Gupta, Managing Director and Chief Financial Officer of State Bank of India, RBI is unlikely to cut policy rates this financial year as inflation continues to stay above the central bank’s comfort zone. He added banks would reduce their lending rates only after RBI reversed the rate hike cycle.

Abheek Barua, chief economist of HDFC Bank, said the central bank delivered the dovish rhetoric the market was anticipating amidst rapidly increasing growth concerns. “We believe repo rate cuts could come sooner than initially anticipated — perhaps in the first quarter of 2012-13,” he added.

“It is too early to expect rate cuts as inflation remains high,” Ashvin Parekh, national leader of global financial services at Ernst & Young, said.

RBI kept its growth forecast for 2011-12 unchanged at 7.6 per cent and retained its inflation projection at seven per cent for March 2012. The central bank will make a formal numerical assessment of its outlook on growth and inflation in January 2012.

“Both inflation and inflation expectations are currently above the comfort level of the Reserve Bank. However, reassuringly, inflationary pressures are expected to abate in the coming months despite high crude oil prices and rupee depreciation. The growth deceleration is contributing to a decline in inflation momentum, which is also being helped by softening food inflation,” RBI said.

The banking regulator, however, warned that slippage in this year’s fiscal deficit may have inflationary implications. On a year-on-year basis, headline inflation moderated to 9.1 per cent in November 2011 from 9.7 per cent in the previous month, driven largely by a decline in primary food articles inflation.

RBI did not announce new measures to bolster liquidity in the money markets, although it has been buying back bonds and said it would continue to do so.

Yesterday, the rupee was down nearly 20 per cent from a July peak before RBI took measures to defend the currency, buying rupees in the market and announcing steps to curb speculation. The plunge in the currency has added a sense of alarm to concerns about Asia’s third-biggest economy. The central bank did not unveil further steps on Friday to support the currency. Bond yields and swap rates fell after the policy statement, while the rupee edged lower to 52.70 a dollar after jumping early in the day.