The Reserve Bank of India (RBI) will watch for a sustained fall in inflation before it moves ahead with a cut in policy rates, Deputy Governor Subir Gokarn said on Monday.
"Certainly interest rates will respond to sustained movement in inflation downwards and it is on this basis that we have signaled that this cycle has reached its peak," Gokarn said on the sidelines of an event in Chennai.
With core inflation still stubbornly high, the RBI had as expected left its policy repo rate unchanged at 8.50% for the second consecutive review on January 24.
Inflation has remained high for long due to elevated food prices, infrastructure bottlenecks, and an expansionary fiscal policy that pushed up rural spending power and strained government finances.
However, a sustained fall in food prices since mid-December has given policymakers some respite.
Annual headline inflation, measured by the wholesale price index, slowed to a two-year low of 7.47% in December, thanks to a sharp decline in food inflation. But manufactured product inflation edged up from the previous month.
The 16% drop in the rupee in 2011 has made imports even more expensive.
However, the rupee has gained 7.3% so far in January helped by renewed global appetite and fund flows into local debt.
"Rupee has appreciated by 6 to 7% so some of the inflation impact will obviously get diluted over time," Gokarn said.
The RBI has been intervening in the foreign exchange market to support the rupee, which had slumped to a record low of 54.30 to the dollar in mid-December.
The central bank and the government have also taken other steps to support the currency, including liberalising interest rates for bank deposits held by non-resident Indians as a way to encourage dollar inflows.
Gokarn added that the exchange rate will broadly depend on global liquidity and developments in Europe.
OMOs TO STAY
The central bank is open to more debt buybacks through open market operations to address the strain on liquidity.
"If we need to address liquidity with further OMOs, we are open to that. We are keeping the OMO option open." Gokarn said.
The RBI has bought back about Rs 71,900 crore of government bonds from the secondary market since late November to reduce pressure on yields and ease a cash crunch after the government increased its borrowing plan for 2011-12.
Bank borrowed Rs 1.22 lakh crore from the RBI's repo auction under liquidity adjustment facility on Monday.
RBI had cut CRR, or the share of deposits banks hold with the central bank, by 50 basis points to 5.5% in the latest policy to infuse liquidity. The CRR cut is expected to have released about Rs 32,000 crore into the banking system on Saturday.
