India leaves interest rate unchanged

AP News
Posted: Oct 30, 2012 3:54 AM

MUMBAI, India (AP) — India's central bank left its key interest rate unchanged Tuesday but trimmed the cash reserve ratio, resisting growing pressure from New Delhi to cut rates even as it slashed its growth forecast and raised its inflation projection for Asia's third-largest economy.

Though the Reserve Bank of India left the policy rate at 8.0 percent because of inflation concerns, it did support the government's reform initiative by trimming the cash reserve ratio — the percentage of deposits commercial banks must keep on hand — by a quarter of a point, to 4.25 percent, effective November 3. It said this will inject 175 billion rupees ($3.2 billion) into a cash-constrained banking system.

RBI again slashed its growth outlook for the year ending March, from 6.5 percent to 5.8 percent. Its initial projection was 7.3 percent. The bank said headline inflation will likely hit 7.5 percent in March, up from an earlier forecast of 7.0 percent — and far above the bank's medium term target of 3.0 percent.

RBI has been under growing pressure from New Delhi and business leaders to cut interest rates as growth slipped to its lowest levels since 2009, but the bank says inflation remains its "primary focus."

"Managing inflation and inflation expectations must remain the primary focus of monetary policy," the bank said in its quarterly policy statement Tuesday. The bank said that containing inflation will contribute to consumer and investor confidence, both key to sustaining growth in the medium term.

It said there is a "reasonable likelihood of further policy easing" in the January to March quarter, provided inflation eases as expected and New Delhi's ambitious reform agenda gets translated into action.

After peaking at 9.2 percent in the March 2011 quarter, India's economic growth slid to 5.3 percent a year later, its lowest level since the Great Recession in 2009. Though growth then ticked marginally higher, to 5.5 percent, RBI said the economy is still mired by stalled investment, weakening consumption and falling exports.

India's finance minister, Palaniappan Chidambaram, on Monday announced an ambitious fiscal consolidation plan, which was widely seen as prompt by New Delhi for a rate cut.

Chidambaram said India's fiscal deficit would be 5.3 percent for the year ending March, up from a budgeted 5.1 percent, before falling to 3.0 percent by fiscal 2017. He said the current account deficit would narrow to 3.7 percent of GDP, or $70.3 billion in the year ending March, from 4.2 percent of GDP ($78 billion) the prior year. The government, he added, is confident that the current account deficit will be fully financed through capital inflows. He said all flagship programs to protect the poor by guaranteeing them, for example, jobs and food — which critics say are too costly — will remain untouched.

The speech was part of New Delhi's campaign blitz to restore investor confidence and avoid a ratings downgrade. The government has also recently taken the politically difficult steps of hiking administered diesel prices and loosening some foreign investment restrictions. The moves helped boost the rupee and cheered equity markets.

Chidambaram's fiscal plan, however, came in for criticism as vague and unrealistic, and RBI's Tuesday statement cast into further doubt some of the finance ministry's assumptions.

"They laid down a roadmap but the measures announced so far will not be enough to meet the 5.3 percent deficit," Sonal Varma, economist at Nomura Financial Advisory and Securities in Mumbai, said Tuesday. "The current inflation and current account situation does not give the RBI the space to boost demand at this juncture."

RBI said that from April through August, the fiscal deficit was nearly two-thirds of the entire year's budget and cautioned that it is "expected to be higher than budgeted." The bank also noted the risk of volatile capital flows, and said that given global economic uncertainties financing a large current account deficit "poses challenges."

The bank said the current account and fiscal deficits "continue to pose significant risks to both growth and macroeconomic stability."

The bank praised the government's slew of recent policy announcements for having "positively impacted sentiment," but cautioned that they "need to be translated into effective action to convert sentiment into concrete investment decisions."

Chidambaram greeted the bank's policy decisions with disappointment, telling reporters Tuesday, "To face the challenge of growth, we walk alone."