The Financial Express Subbarao stuns, doesnt cut rates

FE BUREAU Posted: Tuesday, Jun 19, 2012 at 0315 hrs IST

bbarao stuns, doesnt cut rates

Mumbai: The Reserve Bank of India (RBI) on Monday made it clear it was not about to give in to widespread demands for rate cuts and liquidity infusion at a time when the rise in consumer prices continues in double digits and the government itself shows scant regard for inflation as evident in last weeks sharp 15% hike in the minimum support price for farm products. Resisting pressure from virtually every constituency clamouring for lower interest rates and more cash, the central bank left both the key repo rate and the cash reserve ratio (CRR) unchanged at 8% and 4.75%, respectively. However, the central bank reassured the bond markets it would buy back bonds through open market operations (OMO) if needed. It also eased the flow of credit to the export sector, upping the refinance limit for export credit from 15% of outstanding export credit of banks to 50%, releasing R30,000 crore of liquidity. In a message that was loud and clear, the RBI put the blame for sputtering growth squarely on the government. It said the huge subsidy burden was crowding out public investment at time when reviving investment, both public and private, is a critical imperative. Both the bond and equity markets sulked the benchmark yield rose10 basis points to 8.15% while the Sensex gave up 244 points caught off guard by the RBIs resolve to tame inflation before it tackles faltering growth. The central banks stand was vindicated minutes after the monetary policy announcement by the CPI print for May of 10.36%, higher than Aprils 10.26%, signalling retail inflation continues on an uptrend. Moreover, the rise in the WPI of 7.6% y-o-y in May has convinced the RBI that headline inflation remains above levels needed for sustainable growth. Though crude oil prices have slipped below $100 a barrel, the RBI is also prudently preparing for an event shock in Europe that could prompt central banks in the developed world, to opt for another round of quantitative easing. As the central bank cautioned on Monday, a QE3 would clearly have an adverse impact on growth and inflation in emerging and developing economies, particularly on oil importing countries such as India through a possible rebound in commodity prices. Countering perceptions that the high cost of money was hurting growth, the central bank asserted that real effective bank lending rates, though positive, were comparatively lower than the levels seen during the high growth phase of 2003-08. This suggests that factors other than interest rates are contributing more significantly to the growth slowdown, the RBI said.

Economists now believe that rate cuts would come in smaller doses. We maintain our call that the room for monetary policy easing is limited and currently only see scope for up to 50 basis points in rate cuts this fiscal year, observed Leif Eskesen, chief economist, India and ASEAN, HSBC. The RBI has stated that the role of interest rates is small and it feels a reduction in rates could exacerbate inflationary pressures. Our rate call of 50-75 bps rests on government policy action, said Rohini Malkani, economist at Citigroup. The central banks wait-and-watch approach seems to have been appreciated by the government. C Rangarajan, chairman of the Prime Minister's economic advisory council observed that while slowing growth was a valid concern, the RBI did shoulder the responsibility of reining in inflation. So, the right time to look a policy change will be six weeks from now when we have more numbers, Rangarajan said. Indeed, the RBI seems determined to stay with a dear money policy until the government becomes serious about curtailing demand. The central bank pointed out that it had cut the policy rate by 50 basis points on April 17, hoping the process of fiscal consolidation critical for inflation management would get under way, along with other supply-side initiatives. Without mincing words, the RBI held the government responsible for distorting price signals and preventing the much-needed adjustment in aggregate demand for petroleum products by not passing on the higher cost of crude oil price to consumers. It went so far as to say that the huge subsidy burden was crowding out public investment at time when reviving investment, both public and private, is a critical imperative. As Jahangir Aziz, economist at JPMorgan has been pointing out for some time now, the sharp depreciation in the currency of close to 24% over the past year itself has provided a monetary stimulus. The central bank, for its part, pointed out that that the weakening currency had made domestic producers more competitive vis-a-vis foreign producers.