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Monetary Policy: RBI finally bites the bullet - Views on News from Equitymaster
 
 
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  • Jan 29, 2013

    Monetary Policy: RBI finally bites the bullet

    With inflation slowing, the Reserve Bank of India (RBI) finally bit the bullet, and turned its focus towards stimulating growth in the Indian economy. The central bank gave India Inc a bounty of New Year's gifts in 2013, even as it cut the country's GDP growth forecast.

    Thus, in order to boost growth in the economy, the central bank decided to cut the cash reserve ratio (CRR) and the repo rate by 0.25%. These rates now stand at 4% and 7.75% respectively. The cut in the repo rate was widely expected, however the CRR cut is also more than welcome, with an additional Rs 180 bn in liquidity being injected into the system.

    How the situation has changed on the ground

    Globally the situation is seeing some signs of improvement. At the beginning of 2013, the US narrowly avoided falling over the fiscal cliff. And just this week, the Congress voted to suspend the nation's US$ 16.4 trillion borrowing limit until May 19. In Europe also risks of the sovereign debt crisis disrupting the financial system has somewhat ebbed. China is also expected to see a pick-up in the pace of growth.

    On the inflation front, the latest data from India was encouraging. Headline wholesale price index (WPI) inflation eased significantly from 8.1% in September 2012 to 7.2% by December. However, inflation based on the new combined (rural and urban) consumer price index (CPI) rose to 10.6% in December, largely reflecting a surge in food inflation, especially in prices of pulses and other protein-based food items. However, supply side issues still need to be addressed. Keeping in view the moderation in non-food products inflation, and global trends in commodity prices, the baseline WPI inflation projection for FY13 has been revised downwards from 7.5% to 6.8%

    Growth numbers in India were however far less encouraging. Exports contracted in December for the eighth month in a row, reflecting depressed external demand and structural bottlenecks. Imports were higher on the back of higher oil prices and gold imports. In order to stem this, the import tax was hiked from 4% to 6%. The slowdown in net exports and outflows of investment income payments is expected to widen the current account deficit (CAD) further, beyond the level of 5.4% of GDP recorded in 2QFY13. The central bank cut its GDP growth rate forecast from 6.5% (latest revised to 5.8% in October) to 5.5% for FY13.

    Banks have been cautious in lending on account of asset quality stress. However, with policy rates being cut, banks may follow suit which may in turn lead to more credit demand, especially in the final quarter of FY13. However, the RBI has kept its credit growth forecast unchanged at 16%.

    Going forward

    The RBI finally responded to pressure from the industry and the government to cut rates. A monetary cut at this time will help improve sentiments and revive growth. The major reasons the central bank opted for a rate cut at this stage was on account of slowing inflation and GDP growth falling well below the trend line. However, risks still remain in the Indian economy with respect to the historically high CAD, global contagion risks, sticky inflation, and various policy/structural issues still persist for investment in the infrastructure sector. Future monetary policy stance will largely depend on the government's policy initiatives. Recent government reforms, especially partial deregulation of diesel prices, has staved off near term risks on the fiscal front. However sustained fiscal consolidation is needed in order to create room for further monetary easing. Well, all eyes are now on the Union Budget due at the end of February.

     

     

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