Mumbai: The Reserve Bank of India (RBI) on Friday signalled the end of the rate increase cycle that started in March 2010 amid concerns over growth slowing, even as prices remain untamed.
After 13 increases, which raised the policy rate from 3.25% to 8.5% to curb persistently high inflation in Asia’s third largest economy, the Indian central bank pressed the pause button and said, “further rate hikes might not be warranted”.
Even though inflation continues to remain high, way beyond its comfort level, slowing economic growth has emerged as a bigger concern for RBI and it said “from this point on, monetary policy actions are likely to reverse the cycle”, without saying when that will start.
RBI acknowledged moderation in growth momentum and “higher downside risks to growth”, but refrained from committing any timeframe for a reversal in policy stance, with inflation risks remaining high and the local currency under pressure. Wholesale inflation was 9.11% in November and the rupee, Asia’s worst-performing currency, had until Thursday lost 16.6% since August before recovering on Friday.
The central bank left the repo rate, at which it injects liquidity in the system, unchanged at 8.5%. There was no cut in banks’ cash reserve ratio (CRR), the amount of money banks are required to maintain with RBI. It was kept unchanged at 6%, even though the daily cash deficit in the system has been an average Rs 89,000 crore this month and can rise.
Bond yields and swap rates fell after the policy announcement. The yield on the most-traded 10-year government bonds fell 11 basis points to close at 8.38%.
The rupee rebounded from its lifetime low following RBI’s Thursday move of not allowing companies as well as institutional investors to re-book forward contracts after cancelling them. It opened at 52.90 per dollar, up from Thursday’s close of 53.64, and gained 2.7% to touch 52.21 before ending at 52.74 per dollar.
The end of the rate increase cycle, however, did not have any impact on the stock market. India’s bellwether equity index, the Sensex, closed down 2.2%.
Finance minister Pranab Mukherjee said RBI’s move would help in regaining “our growth momentum with improved macroeconomic parameters in the remaining period of the current fiscal”.
The need to improve business sentiment and recover growth momentum in the remaining months of the current fiscal necessitated a review of the monetary policy stance, he said.
“I cannot speculate on when we will start cutting policy rates. Rate cut is an event some way ahead,” RBI governor D. Subbarao told reporters at the sidelines of an event in Mumbai and said the central bank will ensure adequate liquidity in the system by buying bonds from the secondary market.
Industry lobbies were largely non-committal about the policy, while sounding notes of caution.
“While we feel inflation rates will be coming off in next couple of months, there will be a significant uptick on imported inflation, given the rupee depreciation,” said Rajiv Kumar, secretary general of the Federation of Indian Chambers of Commerce and Industry. “To this end, RBI should continue to be vigilant and proactive in its exchange rate management.”
“The growth slowdown is clearly visible as downside risk still remains negative. The industry can expect a possible rate cut in the days to come,” said Associated Chambers of Commerce and Industry of India in a statement.
Tushar Poddar, economist at Goldman Sachs, does not see a rate cut as being too far away, but not too many economists share his view, even though almost all say RBI’s stance is now “dovish” or “less hawkish”.
“Given the dovish tone adopted by RBI and the rapidly deteriorating growth environment, we bring forward our forecast of the first repo rate cut to 24 January from March,” Poddar said.
Rajeev Malik, senior economist at CLSA Singapore Pte Ltd, termed the guidance in the statement as “dovish”, and said the absence of a change in CRR shows RBI’s “reluctance to announce easing just yet”. He expects RBI to start easing policy with a CRR cut from its third quarter policy review on 24 January and subsequent rate cuts after the budget in February.
Lief Eskesen, chief economist for India and Association of Southeast Asian Nations at Hongkong and Shanghai Banking Corp. Ltd, expects RBI to be on hold for a while. While growth and inflation concerns are now more evenly matched, it will be difficult for RBI to cut rates unless underlying inflation pressures ease significantly and on a sustained basis, he said.
“We do not see that happening anytime soon, and the decline in headline inflation in coming months, largely due to base effects, should not be taken as a cue either,” he said.
Taimur Baig and Kaushik Das, economists at Deutsche Bank AG, said RBI was not keen to take the lead in dealing with slowing growth.
“Clearly, the view is that growth cannot be tackled by easy monetary policy alone, and, therefore, expectations of major growth supportive measures from RBI should be tempered,” they said.
They expect the rate-cutting cycle to start mid-2012, “with some chance of it starting from March onwards, depending on the inflation-growth dynamics.”
Chanda Kochhar, managing director and chief executive officer of ICICI Bank Ltd, India’s largest private lender, said the decision to keep rates unchanged was a positive one.
“The mid-quarter policy statement has addressed the concerns on the interest rate side by clearly indicating a likely reversal in the cycle, with monetary policy action being directed towards addressing growth-related issues going forward,” she said in an emailed comment.
With RBI maintaining status quo on policy rates, bank lending rates are likely to remain the same in the immediate future, analysts said.
“Banks have already responded to RBI’s rate actions in the past by increasing their rates. I do not expect any change in the deposit or lending rates in the immediate future,” said Vaibhav Agarwal, vice-president, research, at Mumbai-based brokerage Angel Broking Ltd.
RBI doesn’t see any stress in the money market even though daily liquidity infusion by the central bank has been around RS 89,000 crore in November-December, up from around Rs 49,000 crore in April-October. Banks have not yet utilized the marginal standing facility, an extra liquidity infusion window that RBI has opened for banks where money is available at 9.5%.
While it refrained from a cut in CRR, the central bank also stayed away from giving a time table on its bond-buying programme through the so-called open market operations (OMOs). It has so far infused at least Rs 24,000 crore through OMOs and it will have to conduct more of these as rupee liquidity is being sucked out because of its dollar sales. RBI has been selling dollars to stem the local currency’s depreciation.
Despite the cash shortage in the system, it has not cut CRR or announced an OMO calendar, as it does not want banks to take advantage of the liquidity assurance and take bets on the rupee.