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Mumbai, June 18: Reserve Bank governor Duvvuri Subbarao stunned the Street once again: this time by refusing to cut benchmark interest rates, adopting a counter-intuitive monetary policy that appeared to defy the government, which had sent out clear signals last week that it wanted rates to be trimmed.
The decision to stand firm on rates flew in the face of market pundits who had been anticipating at least a 25-basis-point reduction in the repo.
The Indian economy slowed to 6.5 per cent in the year ended March — its slowest growth in nine years, triggering a clamour from India Inc and the nudge from the government for a rate cut.
But the RBI and Subbarao resisted the pressures, arguing that the decision to stand pat on interest rates was taken because inflation was threatening to spin out of control.
The RBI’s policymakers said they were not convinced that a rate cut could kickstart the stuttering economy.
As a result, the repo rate was left unchanged at 8 per cent and the cash reserve ratio (CRR) at 4.75 per cent.
The repo is the rate at which the RBI provides funds to banks; CRR is that portion of deposits that banks must park with the apex bank.
In Delhi, finance minister Pranab Mukherjee said he was disappointed that the RBI had chosen not to cut rates. High inflation “might have weighed their (RBI’s) decision-making process. And normally in mid-quarter review, it is not necessary for the RBI governor to consult the minister”, Mukherjee said.
Last Saturday, Mukherjee had said that the RBI would take steps to “adjust monetary policy” to address the economic issues — inflation and growth — facing the country.
Commerce minister Anand Sharma — seen as a possible replacement for Mukherjee if he moves to Rashtrapati Bhavan — said he would write to the finance ministry and the RBI demanding a relook. “The RBI’s decision is disappointing and will not help in reversing the trend when it comes to the core sector manufacturing.”
Sharma said he had been expecting “some positive news” that would spur investments.
Industry was also mortified by the RBI’s decision to stand firm on rates.
“It needs to be understood that with a steadily declining GDP growth, millions of livelihoods are under threat and therefore, a very inflation-centric policy measure appears to have missed the bigger picture,” said Chandrajit Banerjee, director-general of the Confederation of Indian Industry.
Car makers and real estate players — which have been struggling in the economic downturn — were upset by the RBI’s decision.
“For the car industry, it is very important that the interest rates come down as 70 per cent of sales are financed,” said Mayank Pareek, chief operating officer (marketing and sales) at Maruti Suzuki India.
Although industry was disappointed, the monetary policy provided some benefits to the exporting community.
The eligible limit for the Export Credit Refinance (ECR) facility for scheduled banks has been raised from 15 per cent of the outstanding export credit eligible for refinance to 50 per cent.
The RBI said the move would provide additional liquidity support to banks of over Rs 30,000 crore. The new rule will be effective from the fortnight beginning June 30. The rate of interest on the ECR facility will be 8 per cent.
Lens on rate cut
Back in April, Subbarao had stunned the Street for the first time by slashing the repo by 50 basis points to 8 per cent — the first rate cut in three years — signalling a reversal of the hawkish monetary policy he has pursued for over three years.
The RBI today questioned the popular view that high lending rates had scuppered India’s growth.
“It is relevant to assess as to what extent high interest rates are affecting economic growth. Estimates suggest that real effective bank lending interest rates, though positive, remain comparatively lower than the levels seen during the high growth phase of 2003-08,” the RBI said. “This suggests that factors other than interest rates are contributing more significantly to the growth slowdown.”
The central bank said the domestic macro-economic situation raised myriad concerns. Although growth in 2011-12 moderated significantly, headline inflation remained high.
It also warned that in the event of another global shock, the central banks in advanced economies would probably start another round of quantitative easing. This would have an immediate knock-on effect on both growth and inflation in emerging economies such as India because of an anticipated rebound in commodity prices.
Although core inflation (non-food manufactured products) has softened, the presence of inflation both at wholesale and retail levels despite a slowdown in the economy indicated that there were supply bottlenecks and sticky inflation expectations.
“In the absence of pass-through from international crude oil prices to domestic prices, the consumption of petroleum products remains strong distorting price signals and preventing the much needed adjustment in aggregate demand. The consequent subsidy burden on the government is crowding out public investment at a time reviving investment, both public and private, is a critical imperative,” it added.
Adopting a cautious outlook, the RBI said evolving growth-inflation dynamics would continue to influence its stance on rates. “Both headline and retail inflation rates are rising, which have a bearing on inflation expectations. Future actions will depend on a continuing assessment of external and domestic developments that contribute to lowering inflation risks.”
Economists said the RBI’s decision was pragmatic.
“Today’s RBI action was a fine balancing act between growth and inflation amid rising stagflationary pressures. In its assessment, rate reduction at the current juncture will add more to inflation than to growth, given that the present slowdown is driven by structural impediments,” said Rupa Rege Nitsure, chief economist at Bank of Baroda.
Stagflation occurs when decelerating GDP growth is accompanied with rising retail inflation.
“We are pleased to see that the RBI went against consensus expectation today to leave the policy stance unchanged. The central bank put the onus of economic recovery, rightly in our view, on fiscal-structural policies,” a note from Deutsche Bank said.
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