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RBI Warns On Inflation; Likely To Hold Rates

BW Online Bureau Nov 08, 2014

<?xml version="1.0" encoding="UTF-8"?><root available-locales="en_US," default-locale="en_US"><static-content language-id="en_US"><![CDATA[The Reserve Bank of India (RBI) said the growth outlook and business climate have weakened but warned of upward risks to inflation, a day before it is widely expected to keep policy interest rates on hold. Indicating that it may not tweak interest rates in Tuesday's policy review, the Reserve Bank said on Monday it will try to strike a balance between the need for promoting growth and containing inflationary expectations. The RBI said that GDP growth during the current fiscal is likely to fall below its earlier projection of 7.6 per cent, while inflation, which is still a cause for concern, may moderate to 7 per cent by March-end. "Even as the growth slowdown emerges as the major challenge, inflation risks persist, posing a challenge for monetary policy in achieving low and stable inflation with minimal sacrifice of growth," said the Macro-Economic and Monetary Developments Review released by the RBI on the eve of the third quarter policy announcement. Consequently, "Monetary actions will need to strike a balance between risks to growth and inflation," it said. "Growth is likely to turn weaker than earlier anticipated," the RBI said. The government also said growth could be around 7 per cent in 2011-12, down from 8.5 per cent a year ago. The RBI left interest rates unchanged in December after raising them 13 times between March 2010 and October 2011. Economists say it may choose to cut the cash reserve ratio (CRR), the share of deposits banks must maintain with the central bank, from 6 percent, to ease tight liquidity, at its review on Tuesday. "The critical factors in rate actions ahead will be core inflation and exchange rate pass through," the RBI said on Monday in its quarterly review of macroeconomic and monetary developments. The rupee depreciated by 16 per cent against the dollar in 2011, putting upward pressure on prices of imported goods, especially energy. Commenting on the recent improvement in the price situation, the RBI said, "While in the short run, moderating inflation will provide some space for monetary policy to address growth concerns, in the absence of structural measures to address a range of supply bottlenecks, this will be temporary respite." Overall inflation, which has remained near double digits for 11 months, declined to 7.5 per cent in December, 2011. Investment in industrial capacity that would ease supply bottlenecks in Asia's third-largest economy has been slowed by sluggish decision-making in New Delhi, while programs that increase the spending power of rural Indians has driven up demand for items such as protein-rich foods. The central bank said that while open market operations -- buybacks of bonds from the market by the central bank -- have been its weapon of choice for addressing tight market liquidity, other measures could be considered. "Enabling smooth functioning of other markets by ensuring that the liquidity deficit remains within acceptable limits is also a policy priority," the report said. Expressing concern over the deterioration in the fiscal position of the government, the RBI suggested that the government should move ahead with reforms, especially in direct and indirect taxes. "The central government's deficit indicators are under duress due to higher subsidies and lower tax collections. Fiscal reforms, including the Direct Taxes Code and Goods and Services Tax, are, therefore, needed to contain deficits in 2012-13," the RBI said. It also called for budgetary solutions to contain the growing subsidy commitment in order to enhance the potential growth rate of the economy. Last month, Finance Minister Pranab Mukherjee had said the subsidy burden in FY'12 could exceed Budget estimates by Rs 1 lakh crore. This is likely to put pressure on the fiscal deficit, which is projected at around 4.6 per cent of the GDP. It said that a widening current account deficit (CAD) and a mounting revenue deficit is putting the fiscal position under strain and impacting the government's wherewithal for capital spending. The report admitted that the liquidity deficit is higher than what suits the RBI, but did not say anything specific on measures to be adopted, like a cut in the cash reserve ratio (CRR), as banks have been asking. Banks have borrowed nearly Rs 1.5 lakh crore from the overnight borrowing window in the past few weeks, leading to demands for a cut in the CRR, or the amount of deposits banks park with the RBI. The RBI has hiked interest rates 13 times since March, 2010, to control inflation. Industry is of the view that repeated rate hikes have made borrowings costlier and has impacted investments. With inflation undergoing a moderation, the RBI took a pause on its rate hike strategy at its policy review last month. CRR Cut Likely? Economists polled by Reuters last week were unanimous in their view that the Reserve Bank of India will keep rates on hold this week, despite weakening economic growth. A minority - 7 out of 20 - forecast that the RBI would cut the CRR, the proportion of deposits that banks must hold with the central bank, by 25 or 50 basis points from 6 per cent, where it has stood since April 2010. "Liquidity tightness is persisting and it is getting far too uncomfortable. More importantly, it has not eased after the open market operations," said Shubhada Rao, chief economist at Yes Bank, referring to bond buybacks by the central bank. A cut in the CRR would ease banking system liquidity tha has been far tighter than the RBI's target of 1 per cent surplus or deficit in terms of aggregate deposits. Goldman Sachs, however, rates the probability of a 25-basis-point CRR cut on Tuesday at 60 per cent, noting that tight liquidity effectively pushes up rates and pointing out the slow pace of monetary policy transmission in India. "With the long lags in the system, there is a need to start the easing process early to help investor and corporate confidence to kick-start the recovery in 2012," Goldman Sachs economist Tushar Poddar wrote in a note on Monday. Goldman Sachs expects the RBI to cut its 7.5 per cent economic growth forecast for the fiscal year that ends in March, as well as its headline inflation forecast for March. "With a potential set of forecasts which call for lower growth and inflation compared to its earlier projections, the RBI would need to signal a change in stance," Goldman said. The market will scour the bank's quarterly macroeconomic report at 5 pm on Monday for clues on what to expect on Tuesday. While the review is mostly backward-looking, the tone of the comments will be critical. A Reuters poll last week forecast annual Indian GDP growth of 7 per cent in the current fiscal year, far below the 8.5 per cent of a year earlier. The RBI, which held to its hawkish stance long after other major central banks shifted their focus towards lifting growth, left rates on hold at its last review in mid-December but sent a strong signal that its next move would be to ease policy. (With Agencies)