The Reserve Bank of India (RBI) confirmed on Tuesday that India?s economy will slow down sharply this year as it lowered the country?s GDP growth forecast to just 6.5% from the earlier estimate of 7.3% it had put out in mid-April. India?s central bank also raised the inflation forecast to 7% by March 2013 from the earlier 6.5%, given that headline inflation is sticky at over 7% and that there remains potential for prices to rise further in the wake of a weak monsoon, a depreciating rupee and elevated crude oil prices.
Given its resolve to tame inflation, there was, therefore, no room for RBI governor Duvvuri Subbarao to either trim policy rates or cut the cash reserve ratio (CRR), both of which stay unchanged at 8% and 4.75%, respectively. However, always one for a surprise, Subbarao lowered the statutory liquidity ratio (SLR) by one percentage point to 23%, with effect from August 11, a move aimed at facilitating policy transmission and ensuring adequate liquidity. Since most banks hold way more than the mandated 24% of their net demand and time liabilities as gilts, however, there may be no immediate impact. Pratip Chaudhuri, chairman, State Bank of India, however, said banks may use the extra money to lend to new retail customers at lower rates since it would fetch them better returns.
Bond yields inched up as a response to the SLR cut and the move, treasurers said, could keep yields under pressure unless accompanied by open market operations. The equity markets were probably taken aback by the hawkish tone of the document, which suggested that policy rates were unlikely to come down in a hurry.
Indeed, it would appear that a cut in policy rates is some time away given that inflationary pressures remain strongly embedded in the economy and also because the central bank is awaiting concrete steps from the government that would help rein in the fiscal deficit and ease supply-side bottlenecks.
?While the current rate of growth is clearly lower than trend, the output gap will remain relatively small and, under these conditions, demand pressures on inflation can re-emerge quite quickly, exacerbating existing supply pressures,? the central bank governor observed.
The governor stressed the point that while steps to contain fiscal deficit would no doubt help, the RBI would not be driven by any single factor while determining the course of interest rates since the interaction between growth and inflation was becoming complex to understand. ?I see scope (for cutting rates) but cannot really say when it will happen,? Subbarao said, also pointing out that interest rates were not the only factor inhibiting growth. ?Real interest rates are lower than in the pre-crisis period,? the governor observed. Subbarao added that right now, there did not seem to be any downside risk to the GDP growth forecast of 6.5% for 2012-13. Most economists have a growth forecast for the Indian economy of just around 6%.
C Rangarajan, chairman, PMEAC, appreciated the central bank?s stance that low inflation was conducive to sustainable growth. ?Cutting the repo would have sent the wrong signal,? Rangarajan said adding that the SLR cut, accompanied by open market operations would help prevent the crowding out of the private sector resulting from large government borrowings. He agreed inflation may hover around 7% but felt growth might come in at higher than 6.5%.
Rohini Malkani, chief economist at Citigroup said that given the truant monsoon, both growth and inflation could overshoot targets with a sub-5% reading on quarterly GDP. Malkani believed there is a rising probability of rating downgrade being factored in by investors.