RBI cuts repo rate by 25 basis points, says little scope for further monetary easing

The Indian central bank cut key policy repo rate by 25 basis points on Friday, in line with street expectations, a move which is expected to soften lending rates in the economy. However, it remains cautious about upside risk to inflation and current account deficit, which may lead to swift reversal of policy stance.

The Reserve Bank of India reduced the repo rate by 25 basis points, from 7.5 per cent to 7.25 per cent with immediate effect, as part of its annual monetary policy statement. Repo rate is the rate at which banks borrow from the RBI.

This is the third time since the beginning of the year that the central bank has cut key policy rates to boost flagging economic growth. In January this year, it cut repo rate by 25 basis points to 7.75 per cent and followed it up with another 25 basis points cut in March. In January, it also cut the cash reserve ratio (CRR).

The reverse repo rate or the rate at which banks buy securities from the RBI and in effect, the interest rate offered by the central bank for funds parked by commercial banks, has been automatically adjusted to 6.25 per cent. The reverse repo rate differs from the repo rate with a spread of 100 basis points.

The bank rate has been adjusted to 8.25 per cent. However, the central bank has left the CRR unchanged at 4 per cent.

“The policy action undertaken in this review carries forward the measures put in place since January 2012 towards supporting growth in the face of gradual moderation of headline inflation,” RBI said in a statement.

It has also said that the recent monetary policy action, by itself, cannot revive growth and the economy needs easing of supply bottlenecks, improving governance and stepping up public investment, alongside continuing commitment to fiscal consolidation.

“With upside risks to inflation still significant in the near term in view of sectoral demand-supply imbalances and ongoing correction in administered prices and pressures stemming from MSP increases, monetary policy cannot afford to lower its guard against the possibility of resurgence of inflation pressures. Monetary policy will also have to remain alert to the risks on account of the CAD and its financing, which could warrant a swift reversal of the policy stance,” it added.

Striking a cautious near-term outlook for policy stance, it said, “The balance of risks stemming from the Reserve Bank’s assessment of the growth-inflation dynamic yields little space for further monetary easing.”

The next mid-quarter review of monetary policy for the current fiscal year is scheduled for June 17, 2013, while the first quarter review of the policy for 2013-14 is scheduled for July 30. 

Growth outlook and risk factors 

According to the central bank, during 2013-14, economic activity is expected to show only a modest improvement over the last year, with a pick-up likely only in the second half of the year. Also, depending on a normal monsoon, agricultural growth may return to trend levels. 

“The outlook for industrial activity remains subdued, with the pipeline of new investment drying up and existing projects stalled by bottlenecks and implementation gaps. With the global growth unlikely to improve significantly from 2012, growth in services and exports may remain sluggish. Accordingly, the baseline GDP growth for 2013-14 is projected at 5.7 per cent,” stated RBI.

It also noted that the wholesale price inflation for March 2013 at 6 per cent turned out to be lower than its projection of 6.8 per cent, mainly due to a sharp deceleration in non-food manufactured products inflation in the second half of the year. 

“The global inflation outlook for the current year appears more benign, compared to last year, on expectations of some softening of crude oil and food prices. Accordingly, imported inflation is likely to be lower, provided the exchange rate remains broadly stable. Indicators of corporate performance, industrial outlook and PMIs are pointing to a declining pricing power,” it said. 

But according to the central bank, food inflation is likely to be a source of upside pressure because of persisting supply imbalances. Also, the timing and magnitude of administered price revisions, particularly of electricity and coal, will impact the evolution of the trajectory of inflation in 2013-14. 

RBI has projected WPI inflation to be range-bound at around 5.5 per cent during 2013-14, with some edging down in the first half on account of past policy actions, although there could be some increase in the second half, largely reflecting base effects. It has said that it is targeting to bring down inflation to its comfort zone of 5 per cent by March 2014, using all policy instruments at its command.

Referring to the factors which could yet derail its growth, RBI attributed the biggest risk to the economy to current account deficit, which was historically highest last year and well above the sustainable level of 2.5 per cent of GDP, as estimated by the central bank.

RBI has observed that sustained revival of growth is not possible without a revival of investment and investment sentiment remains inhibited owing to subdued business confidence and dented business profitability.

“Both borrowers and lenders have become risk averse. Borrowers have become risk averse because of governance concerns, delays in approvals and tighter credit conditions. For lenders, risk aversion stems from the erosion of asset quality, deteriorating cash flow situation of borrowers eroding their credit worthiness and heightened risk premiums,” it added.

(Edited by Sanghamitra Mandal)

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