Relief! Dovish RBI does not increase policy rate, ratios

The Reserve Bank of India today kept its policy rate and ratios unchanged as expected, in an unexpectedly dovish statement.

The central bank, however, cut the growth estimate for the year to 5.5 percent from 5.7 percent earlier. It also said it targeted an inflation rate of 5 percent for March 2014.

The inflation target is keeping in view of the domestic demand-supply balance, the outlook for global commodity prices, and on the expectation that spatial and temporal distribution of the monsoon during the rest of the season will be normal.

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As far as growth is concerned, the persisting weakness in industrial activity has heightened the risks, it said.

However, it recognised the government’s efforts.

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“Over the last one year, the Government has taken several policy initiatives to improve the investment environment. As these initiatives work through the system and are further built upon, the current slowdown could be reversed, returning the economy to a higher growth trajectory,” it said in the statement.

The financial markets heaved a sigh of relief briefly as the policy statements cleared the air over a likely increase in policy repo rate or cash reserve ratio of banks. The markets were down about 0.1 percent as uncertainty about growth outlook dampened sentiment.

The biggest to the macroeconomic outlook stems from the external sector, the RBI said. “It is not clear if financial markets have factored in the full impact of the prospective tapering of QE or whether they will react to every future announcement of tapering,” it said.

India, with its large CAD and dependence on external flows for financing it, will remain vulnerable to the confidence and sentiment in the global financial markets.

It prodded the government to use the recent measures by the RBI to restore stability to the foreign exchange market as a window of opportunity to put in place policies to bring the CAD down to sustainable levels.

“Furthermore, the growing vulnerability in the external sector reinforces the importance of credible fiscal consolidation with accent on both quantity and quality of adjustment.”

It did not, however, give a timeline as to when it would be able to roll back the recent liquidity tightening steps.