Mumbai, July 31: The looming spectre of inflation today forced the Reserve Bank of India to hold its hand on a rate cut even as governor Duvvuri Subbarao pulled out the monetary tool equivalent of a tiny spanner to tweak downward a little-used reserve ratio for banks.
The policy action was in sharp contrast to the sledgehammer that Subbarao hefted exactly a year ago when he tried to clobber inflation with an unexpected 50 basis point hike in the repo rate to 8 per cent.
Inflation was running at 9.5 per cent a year ago; it is hovering at 7.25 per cent now.
The statutory liquidity ratio (SLR), which determines how much banks must mandatorily invest in government bonds, was cut to 23 per cent which could potentially release a cache of Rs 60,000 crore that banks could lend to private borrowers. SLR was cut by one percentage point to 24 per cent back in November 2008.
The two main monetary policy instruments — the repo rate and the cash reserve ratio (CRR) — were kept unchanged at 8 per cent and 4.75 per cent, respectively.
At the same time, the RBI lowered the GDP growth forecast for the year to 6.5 per cent from 7 per cent and raised its inflation projection to 7 per cent from its earlier estimate of 6.5 per cent.
The RBI had a ready answer for those who wanted to know why it chose to leave the repo and CRR rate unchanged.
“Growth moderation suggested that we ease the monetary policy stance. But on the other hand, stickiness on inflation did not allow any room for such easing,” said Subbarao.
The RBI governor said in the current circumstances, lowering policy rates would have only aggravated inflationary impulses without necessarily stimulating growth.
Subbarao said while headline inflation has remained sticky, the domestic economy has also been marked by severe supply constraints. Although the economy is now growing below the trend rate of 7.5 per cent, there is a possibility that under the current conditions, demand pressures on inflation could re-emerge, thereby increasing the existing supply pressure.
At his customary post policy press conference, the RBI governor again made no bones about his concerns over inflation. He said it was becoming hard to manage the tension between growth and inflation, which has remained around 7 per cent over the last three months because of an increase in food prices, rise in input costs and the upward revision in the prices of some items such as coal.
Moreover, there are upside risks to inflation. “There are several inflation risks. The first is monsoon. I am told it hits inflation before it hits growth,” he said, adding that a possible drought in parts of the country, could lead to drought related expenditure, thereby putting pressure on the fiscal deficit.
Other factors that could put pressure on prices include higher wages, the structural kink in food inflation and dearer commodity prices.
The central bank reiterated that its primary focus would be to control inflation to secure a sustainable growth path over the medium term.
“While monetary actions over the past two years may have contributed to the growth slowdown — an unavoidable consequence — several other factors have played a significant role… As the multiple constraints to growth are addressed, the Reserve Bank will stand ready to act appropriately,” the apex bank said in a message apparently to the government that it could look at bringing down interest rates if the Centre makes the atmosphere conducive for investment and corrects the fiscal deficit.
Justifying the decision of the RBI to keep key policy rates unchanged to check inflation, Prime Minister’s economic adviser C. Rangarajan said an interest rate cut would have sent out a wrong signal.
“The efforts of the RBI were best to contain inflation. The RBI has struck an appropriate balance to control inflation and to provide stimulus to growth. A repo rate cut would have sent a wrong signal since inflation is high,” he added.
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