The Reserve Bank of India (RBI) kept the key policy rate – the repo rate - unchanged at 8%, but reduced the cash reserve ratio (CRR) by a further 25 bps. We see this move as a token easing (as expected), which should support sentiment in the near term. The CRR now stands at 4.25%. We estimate that this latest CRR reduction will inject Rs 17,500 crore of primary liquidity into the banking system and should be seen as a step to pre-empt additional tightness in liquidity ahead of the festival season.
The policy stance remains cautious, reflecting currently high headline inflation and persisting upside risks to the inflation trajectory in the near term. Nevertheless, we think policy rhetoric has turned distinctly more balanced at the margin compared with the previous two decisions in acknowledging growth concerns and highlighting the necessary role of monetary policy in any growth revival. Current policy guidance of “a reasonable likelihood of further policy easing in the fourth quarter of FY 12-13” is in line with our baseline scenario.
RBI recognises need for growth support, but high inflation a constraint
The RBI remains constrained by high inflation. Indeed, while the headline inflation rate of nearly 8% yo-y in September was driven largely by administered price hikes, “core” inflation of ~5.6% clearly remains beyond the RBI’s comfort. It is difficult to see the Indian central bank reducing its focus on inflation management in the near term, especially when it is guiding for inflation to move higher into the year end.
While the RBI downgraded its GDP growth projection to 5.8% from 6.5% for FY 12-13 (Barclays: 5.8%), it raised its inflation forecast at 7.5% by March 2013, up from 7.0% earlier. In terms of the trajectory, we think the central bank expects inflation to rise over the next three months, possibly crossing 8%, before moderating to 7.5% by March 2013 (Barclays: 7.75%).
Nevertheless, the policy stance has been easing gradually, in sympathy with declining growth figures. The retention of an above growth-inflation assumption also points to further policy easing, in our view, but it is likely to be backload and delivered only when there are definite indications of inflation peaking. Even with the improvement in the monsoon rainfall, the RBI has expressed concerns over the poor price elasticity of food prices, and with non-food prices also rising, the RBI expects inflation to remain above its comfort zone. What could change this outlook would be a sharp drop in commodity prices. But that remains a low probability event, in our view.
RBI guidance supports our view of rate cut in Q1 2013
We maintain our view of further rate cuts in Q1 2013 and continue to forecast a 100bp reduction in the repo rate during H1 13. While holding back from making rate cuts, we think the Indian central bank recognises the need to support faltering growth, and expect it to continue to provide liquidity to meet its money and credit growth targets. We think a further cut in the CRR is possible if the liquidity situation warrants, but the RBI will likely use this tool less aggressively, given that the rate has already been reduced by 175bp in 2012 and is at an historical low. Open market operations (OMOs), which have been used to inject over Rs 80,000 crore of liquidity during FY 12-13, will likely remain a key tool to inject liquidity in the coming months, in our view.
Siddhartha Sanyal is Chief India Economist, Barclays Capital and Rahul Bajoria is regional economist, Barclays Capital
