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UPDATE 2-India central bank holds rates steady, ups inflation forecast

by on July 31, 2012 8:18 am BST
 

Tue Jul 31, 2012 4:18am EDT

* RBI leaves policy repo rate unchanged at 8 percent

* Cuts GDP growth forecast for fiscal year to 6.5 pct

* Raises WPI inflation outlook for fiscal year to 7 pct

* Cuts minimum bond holding requirement for banks

* Bond yields, swap rates rise after policy, SLR cut

By Suvashree Dey Choudhury and Tony Munroe

MUMBAI, July 31 (Reuters) – India’s central bank left
interest rates unchanged on Tuesday for the second straight
review, showing that bringing down stubbornly high inflation is
its top priority even as economic conditions deteriorate.

Underlining its policy dilemma as it faces pressure to
reduce rates, the Reserve Bank of India (RBI) cut its economic
growth forecast for the fiscal year to March 2013, while at the
same time raising its inflation forecast.

The RBI left its policy repo rate at 8 percent
and cash reserve ratio for banks at 4.75 percent.
The CRR is the share of deposits banks must keep with the RBI.

“In the current circumstances, lowering policy rates will
only aggravate inflationary impulses without necessarily
stimulating growth,” Governor Duvvuri Subbarao wrote in the
monetary policy review.

The RBI’s primary focus remains inflation control, he added.

The central bank’s hard line on rates sits in contrast to
many other central banks that are easing credit conditions to
try to bolster economies feeling the impact of the euro zone
debt crisis.

The stance maintains pressure on Prime Minister Manmohan
Singh’s government to rein-in populist subsidy spending and take
other steps to bolster an economy growing at its weakest pace in
almost a decade.

A Reuters poll of 20 economists last week showed all but one
expected the RBI to hold rates steady.

Many economists expected the central bank to resume cutting
rates only in the second half of the fiscal year, a nd modestly
at that.

” Given the inflationary risks and pressures, which I don’t
see going away, we will continue to see high inflation in the
rest of the year,” said Abheek Barua, chief economist at HDFC
Bank in New Delhi. “In the foreseeable policy horizon, I do not
see RBI cutting rates,” he said.

MARKET DOUBTS

Wholesale price inflation remained above 7
percent in June and consumer price inflation was 10 percent.
Growth in Asia’s third-largest economy slowed to a nine-year low
of 5.3 percent in the March quarter.

On Tuesday, the central bank cut its economic growth outlook
for the fiscal year that ends in March to 6.5 percent, from the
7.3 percent assumption made in April, putting its outlook closer
to that of many private-sector economists.

It also raised its headline inflation projection for March
2013 to 7 percent from 6.5 percent in its April review, further
denting market hopes for policy easing in the near term.

The central bank unexpectedly cut the minimum requirement
for banks’ government bond holdings to 23 percent of deposits
from 24 percent, a move to free up liquidity. However, some
bankers said the cut was unlikely to spur more lending given
worries about deteriorating credit quality in the slowing
economy.

The 10-year benchmark bond yield was up 8
basis points at 8.23 percent from its previous close, after
rising to as much as 8.28 percent. The 5-year OIS rate
rose 10 bps to 7.10 percent, while the 1-year
rate rose 4 bps to 7.68 percent.

India’s main stock index gave up brief gains and
was down 0.4 percent on worries the RBI will not cut rates
anytime soon.

“The Reserve Bank of India struck a hawkish stance in its
monetary policy statement,” said Anubhuti Sahay, an economist at
Standard Chartered Bank in Mumbai. “Overall it affirms our view
that any rate cut from the RBI is unlikely in rest of 2012.”

The RBI cut rates by a steeper-than-expected 50 basis points
in April but has kept a hawkish stance since, even in the face
of widespread expectations in June it would cut rates again.

“Headline inflation has persisted even as demand has
moderated and the pricing power of corporates weakened,”
Subbarao wrote. “Non-food manufactured products inflation has
also not declined to the extent warranted by the growth
moderation. This reflects severe supply constraints and
entrenchment of inflation expectations.”

OUTLIER INDIA

The RBI’s hawkish stance makes it an outlier compared with
the likes of China, Brazil and South Korea, which have eased
monetary policy in recent weeks to bolster their flagging
economies.

The central bank has repeatedly called on the government to
take steps to revive investment by implementing long-pending
reforms, such as allowing foreign direct investment in the
supermarket and airline industries, and to cut populist spending
that bloats its fiscal deficit.

On Tuesday, it said an immediate cut in fuel and fertiliser
subsidies was needed if the government is to reach its target of
cutting subsidies to less than 2 percent of GDP in fiscal
2012/13.

“The path of monetary easing would henceforth be guided by
the pace of fiscal reforms with near-term focus on expenditure
restructuring,” said Shakti Satapathy, fixed income strategist
at AK Capital in Mumbai. “A delayed response from the
government’s end might handicap the quantum of rate cut in the
forthcoming policy meet,” he said.

The RBI’s next rate review is Sept. 17.

India’s fiscal deficit for the fiscal year that ended in
March was 5.76 percent of GDP, and many economists say its aim
to trim that to 5.1 percent for this fiscal year is optimistic.

India has seen a dramatic slide in its economic fortunes
compared to the years before the global financial crisis when
growth rates were closer to 10 percent.

The rupee has slumped to a record low this year
against the dollar and the country’s current account, the
broadest measure of trade in goods and services with the rest of
the world, has hit a record deficit.

Investment has also suffered. A study last week by Indian
rating agency Crisil found that capital expenditure by 170
private-sector companies will fall by 35 percent on average in
the fiscal year that ends in March.