The Reserve Bank of India (RBI) left its short-term rates and banks' cash reserve requirement unchanged as expected on Tuesday and stressed that its priority is to nurture growth, although it lifted its forecast for wholesale prices in a sign of tightening measures to come.
The RBI said it would maintain a policy of easy money while the outlook remained uncertain, reassuring a bond market that must absorb a record 4.51 trillion rupees ($94 billion) in government borrowing this year as New Delhi manages a fiscal deficit expected to reach 6.8 percent of GDP.
It said once a recovery had taken hold, it would be ready to reverse some expansionary measures to keep a lid on inflation. The RBI increased its outlook for wholesale price inflation for the year that ends in March to 5 percent from an earlier 4 percent target.
"It is worth reiterating that the Reserve Bank will maintain an accommodative monetary stance until there are definite and robust signs of recovery," it said in its review.
"The exit strategy will be modulated in accordance with the evolving macroeconomic developments," it said, without setting a timeframe.
The yield on the 10-year bond eased after the RBI report, which also said it would actively manage liquidity to prevent government borrowing from crowding out private demand for credit.
Market players said they expect bonds to remain range-bound.
The spread between one-year and 10-year bonds was unchanged at 309 basis points, below last week's record of 326 basis points, and front-end swaps edged lower by 2 basis points.
Those spreads soared in recent months, reflecting market concerns about record government debt supply and some speculation that inflation fears may force the central bank to start tightening policy even before recovery is in full swing.
The rupee was largely unchanged while stocks ended 0.28 percent lower.
The Reserve Bank left its gross domestic product forecast for the current fiscal year unchanged at 6 percent, but with a bias to the upside.
The RBI said it was unlikely that growth momentum would pick up before the middle of the current fiscal year, but said it expected fiscal and monetary stimulus measures to boost domestic demand in 2009/10.
"The RBI is still working in conjunction with the fiscal policy, which is trying to nurture growth," said Sachchidanand Shukla, economist at Enam Securities in Mumbai, adding that the focus would shift to battling inflation by the end of 2009/10.
Goldman Sachs economist Tushar Podder said the central bank's explicit mention of inflationary pressures signals a move away from a singular focus on demand growth.
"The RBI statement gives more support to our view that the RBI will start hiking interest rates in early 2010, due to latent inflationary pressures and strengthening aggregate demand," he wrote.
Analysts polled by Reuters after Tuesday's review said rates are likely to remain steady for the rest of 2009, with a growing risk of a rate increase seen in early 2010.
RATES ON HOLD
The RBI left its lending rate steady at 4.75 percent, its lowest in nine years, and its reverse repo rate, at which it absorbs surplus cash from the banking system, also unchanged at 3.25 percent.
Both rates were last cut by 25 basis points in April.
The RBI kept the cash reserve ratio (CRR), the amount of funds banks have to keep on deposit with it, unchanged at 5.0 percent. It was last cut by 50 basis points in January.
Commercial lenders have been investing as much as 30 percent of their deposits in government bonds -- above a requirement of 24 percent -- and officials have been calling on banks to step up lending to help boost the economy.
The RBI said on Tuesday that commercial banks have room to lower deposit and lending rates.
Asia's third-largest economy grew 6.7 percent in the last fiscal year after expanding by 9 percent or more in the previous three years. Private sector economists expect growth between 5.8 and 7.2 percent this year.
Wholesale prices are below last year's levels, largely as a result of oil prices retreating from all-time peaks reached in July 2008. But they have been rising since March, while consumer price inflation hovers near 8 percent and a lacklustre monsoon season threatens higher food prices.
"Global commodity prices have rebounded ahead of global recovery and the uncertain monsoon outlook could further accentuate food price inflation," central bank Governor Duvvuri Subbarao said.
The RBI has cut its short-term lending rate by 425 basis points since October. The reverse repo rate, at which the RBI absorbs surplus cash, has been cut by 275 basis points in four steps since December.