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India keeps key interest rate on hold

July 31, 2012


Reserve Bank of India’s logo.—Reuters Photo
Reserve Bank of India’s logo.—Reuters Photo

MUMBAI: India's central bank kept its key interest rates unchanged on Tuesday as predicted, but it delivered bleak forecasts for the slowing economy and warned about the country's deficits.

The Reserve Bank of India (RBI) said the benchmark repo rate, at which it lends to commercial banks, would remain at 8.0 per cent because of the risks of higher inflation.

“In the current circumstances, lowering policy rates will only aggravate inflationary impulses without necessarily stimulating growth,” said RBI governor Duvvuri Subbarao in a release after Tuesday's decision.

The move to hold interest rates had been widely expected by economists after the bank hinted in a report released late Monday that it was unable to cut them further because of inflationary pressures.

India's once-booming economy grew just 5.3 per cent between January and March, its slowest annual quarterly expansion in nine years, and the bank revealed gloomy predictions for the near-term.

It slashed its GDP growth forecast for this financial year to April 2013 from 7.3 per cent to 6.5 per cent, while predicting that inflation at the end of the year would be 7.0 per cent instead of 6.5 per cent as forecast.

“India is clearly an outlier — even though our growth is slowing in line with the rest of the world, our inflation continues to be high,” Subbarao told a news conference.

Wholesale inflation stands at 7.25 per cent — far above the bank's comfort level of five to six per cent — while the consumer price index, which covers a smaller band of goods, is at 10.02 per cent.

While other central banks around the globe have been easing interest rates to revive their troubled economies, the RBI has said that economic reforms are needed first in order to remove chronic bottlenecks in the economy.

Subbarao also warned about the deficit in India's current account, largely caused by its large import bill, and its fiscal deficit, caused by government overspending.

“Failure to narrow twin deficits with appropriate policy actions threatens both macroeconomic stability and growth,” he said.

Glenn Levine, an economist at Moody's Analytics, said ahead of the announcement that India faced “stagflation”.

“The economy is slowing while inflation remains high,” he said.

In a move to stimulate growth, the bank cut its statutory liquidity ratio for commercial banks by 100 basis points to 23 per cent on Tuesday.

This reduces the amount of short-term liquid assets that banks have to hold in reserves and should help to boost the credit available to businesses.

The bank lowered rates in April to kickstart growth — its first such move in three years. But it has since kept monetary policy steady, citing inflationary pressures, despite calls from business leaders to stimulate the economy.

“This is an intelligent policy. The upside risks to inflation are rising and the RBI has attached more weight to this,” said Rupa Rege Nitsure, chief economist with state-run Bank of Baroda, after Tuesday's decision.

A weak monsoon, in which the rains have been more than 20 per cent lower than normal so far, has stoked the bank's inflation worries because of the potential impact on food prices if crops fail.

India's projected growth remains enviable by Western standards but it is too slow to fulfil government pledges of significant poverty reduction and to create enough jobs for a soaring young workforce in the country of 1.2 billion.

The RBI on Monday said the economy was at a “critical juncture” and it encouraged “policy actions to encourage investment”, which would include removing constraints on foreign direct investment.