Mumbai: Belying expectations of a softer interest rate regime, Reserve Bank of India (RBI) on Tuesday kept all key rates unchanged in a bid to maintain financial and price stability.
Maintaining status quo in its stance, RBI, in its third quarter review of credit policy, also kept growth projection unchanged at 8.5% and inflation close to 5% in 2007-08.
A 0.75% cut in interest rates by US Federal authorities had led to renewed speculation that India too could follow suit to avert any possible slowdown in the economy. But, Finance Minister P Chidambaram had clearly shown his preference for containing inflation even if it meant balancing growth.
This is for the first time in the last two years that Reserve Bank has not hiked the key rates indicating that the monetary policy of borne fruits in sense of price and financial stability.
However, it gave a policy prescription to the government to “effectively, demonstrably and convincingly indicate commitment to managing capital flows consistent with macro fundamentals through appropriate and decisive policy action.”
This assumes significance in the wake of volatile global situation with the forecast of recession in US, evident from the recent 0.75% rate cut by the US Federal Reserve.
Adopting a cautious approach, particularly with the possibility of rising inflation in the wake of surging global oil prices, RBI kept the benchmark bank rate unchanged at 6%. This is the rate at which the central bank lends to commercial banks.
RBI also decided to keep key short term rates, repo and reverse repo unchanged at 7.75 and 6% respectively.
RBI, however, retained the flexibility to conduct the overnight or longer term repo wholly or partially.
Repo is the rate at which the apex bank infuses liquidity into the system, while reverse repo is a tool to suck out excess liquidity.
The apex bank kept the Cash Reserve Ratio, the ratio of cash balances to be maintained by banks with RBI, at 7.5%.
Highlighting the risk of global financial developments, Reserve Bank asked banks to review large foreign currency exposure to ensure that volatility does not impact their balance sheets of corporate with large external liabilities.
It also asked banks to put in place a system for monitoring such unhedged exposures on a regular basis to minimise risks of instability in the financial system.
Internal limits may be made applicable for foreign currency loans on the basis of a well laid out policy approved by the banks boards, it said.
“Banks are also urged to carefully monitor corporate activity in terms of treasury/trading activity and sources of other income to the extent that embedded credit/market risks pose potential impairment to the quality of banks’ assets,” it said.
While the focus has generally been on managing the excess capital inflows and volatility, it is essential not to exclude the possibility of some change in course due to any abrupt changes in global liquidity, RBI said.
Despite strong fundamentals of the Indian economy, events in the second and third week of January indicated a potential for reversal in capital flows.
“Strategic management of the capital account would warrant preparedness for all situations, and the challenges for managing the capital account in such an unexpected turn of events,” the Reserve Bank said.
It said that liquidity management will continue to assume priority as money supply has been expanding well above projections in 2007-08 driven by high deposit growth despite successive increases in CRR.
Significant volatility has also been observed in the Indian capital markets, along with high capital flows that underlined the need for effective liquidity management, it said.
The domestic factors were better balanced, stable and remain positive, it said adding therefore global factors have increasingly relevant in formulating the monetary policy.
Barring the emergence of any adverse and unexpected developments, the overall policy stance would continue to emphasise price stability, credit quality and monitor the evolving heightened global uncertainties.