RBI obliges FM with a 25 basis rate cut, more easing unlikely

The Reserve Bank of India cut its key policy rate by 25 basis points today for the second time in 2013 to help revive a faltering economy, taking comfort from moderating core price pressures and the government’s commitment to trim the fiscal deficit.

The RBI reduced the repo rate by 25 basis points to 7.5 percent today but left the CRR ( cash reserve ratio) unchanged at 4 percent. However, further monetary easing looks unlikely as the RBI said there is not much headroom from here on due to a recent uptick in headline wholesale inflation, rising food price-driven consumer inflation and a record-high current account deficit, rising food price-driven consumer inflation and a record-high current account deficit.

“Even as the policy stance emphasis addressing the growth risks, the headline for further monetary easing remains quite limited,” the RBI said in its statement.

Despite praising the government for committing to its fiscal consolidation plant, the Reserve Bank also reiterated that the risk on Current Account Deficit and inflation remain significant.

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“Although there has been notable softening of non-food manufactured products inflation, food inflation remains high, driving a wedge between wholesale price and consumer price inflation, and is exacerbating the challenge for monetary management in anchoring inflationary expectations,” the RBI said in a statement today.

The current account deficit hit a record-high 5.4 percent in the September quarter and is expected to end the 2012/13 fiscal year at its highest level ever.February’s wholesale price index rose an annual 6.84 percent, faster than in January, although non-food manufacturing inflation, which the central bank uses to assess demand-driven price pressures, slowed to 3.8 percent, the weakest pace since March 2010.

The central bank, however, said it will continue to infuse liquidity into the financial system through open market operations.

“The Reserve Bank will continue to actively manage liquidity through various instruments, including open market operations (OMO), so as to ensure adequate flow of credit to productive sectors of the economy,” it said.

RBI Guvernor D Subbarao, however, said the biggest challenge for the economy to return to high growth is to revive investment. “A competitive interest rate is necessary for this, but not sufficient. Sufficiency conditions include bridging the supply constraints, staying the course on fiscal consolidation, both in terms of quantity and quality, and improving governance,” he said in his policy review.

A. Prasanna, Economist, ICICI Securities, termed the policy as balanced and said it was similar to January’s stance.

“I wouldn’t characterise it as dovish. The guidance emphasises the point that they are concerned about growth but space for more cuts is limited due to headline inflation and the divergence with CPI,” he said.