Apr 17, 2012|
Monetary Policy: First repo rate cut in 3 years
The Reserve Bank of India (RBI) today finally succumbed to pressure from the government and corporates alike. It has affected a repo rate cut after three years of tightening. Inflation has seen moderation over the previous year. But it still remains sticky on account of global commodity prices and supply side constraints. However, growth in the Indian economy has been the major letdown. This forced the central bank to review its tight liquidity stance. In the first monetary policy review of FY13, the RBI announced its decision to reduce the rates at which it lends to banks (repo rate) by 0.50%. Thus the repo rate now stands at 8% from 8.5% previously. The rate at which RBI borrows from banks (reverse repo) now stands 7% post the review. The central bank left the cash reserve ratio (CRR) unchanged at 4.75%.
A word about growth
GDP growth in India has moderated to 6.1% during 3QFY12 from 6.9% in the previous quarter and 8.3% in 2QFY11. This was mainly on account of a considerable slowdown in industrial growth and a decline in Index of Industrial Production (IIP) numbers. The advance estimate of GDP growth of 6.9% for FY12 by the Central Statistics Office is close to the Reserve Bank's baseline projection of 7% for the period.
The real reason why the central bank cut interest rates by a large quantum was because of a worrying factor. Recent growth and inflation patterns suggest that the growth trend in India has declined from its pre-crisis peak. An economy's trend of growth is the rate that can be sustained over longer periods without stoking demand-side inflation. This decline was due to a number of supply side bottlenecks on the infrastructure, energy, minerals and labour front. A sustained effort on these fronts is needed.
Banking activity is a major indicator of growth in any economy. Non-food credit growth decelerated from 22.1% at the beginning of FY12 to 15.4% by February 2012 reflecting a slowdown in economic activity. However, it picked up to 16.8% as banks rushed to meet their year-end targets. Thus, credit growth came in higher than the indicative projection of 16%. For FY13, the central bank expects moderately higher non-food credit growth of 17%.
What to expect going forward
After raising the policy rate (repo rate) by 3.75% between March 2010 and October 2011 in order to contain rampant inflation, the RBI decided that no further tightening was required. However, it took the conservative central bank almost six months to finally cut interest rates and spur growth in the economy. However, scope for further reduction in rates is modest at the moment.
The year FY13 has started and assuming a normal monsoon, agricultural growth could stay firm. Leading economists suggest a turnaround in IIP growth with a better growth outlook than what was expected earlier. The baseline GDP growth for 2012-13 is thus projected at 7.3%. Thus, the central bank expects the Indian economy to revert to pre-crisis growth in FY13.
Inflation worries, however, are far from over. The RBI has indicated that the path of inflation in 2012-13 could remain sticky around current levels due to high crude prices, exchange rate pass-through, higher freight rates, tax hikes, wage pressure and other structural barriers to supply. Energy prices may remain a significant source of inflation ahead, as artificially suppressed domestic prices of oil, coal and electricity prices are adjusted. There are a number of upward risks to inflation, which the RBI needs to keep in check. Thus, while we expect borrowing costs to get cheaper as most banks have already begun cutting rates, we don't expect a further round of monetary easing anytime soon. Even with a rate cut, the Indian economy is not out of the woods yet. The twin-deficits (fiscal and trade) still loom large and these continue to be major factors that will determine future policy movement.
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