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RBI Monetary 2QFY13 Policy Review

Contributed by Nirmal Bang

Reiterating its concern over persistent inflationary pressure, the Reserve Bank of India (RBI) at its mid-quarter monetary policy review today kept key policy rates unchanged but cut CRR (Cash Reserve Ratio) by 25bps to 4.5% to inject primary liquidity of Rs170bn into the banking system. As a result, repo rate, reverse repo rate and MSF (marginal standing facility) stand unchanged at 8.0%, 7.0% and 9.0%, respectively. Banks will be prime beneficiaries of this additional liquidity infusion, which will increase arbitrage opportunities. We expect the economy and inflation to grow 6.1% and 8.5%, respectively, in FY13.

The government has finally shrugged off its policy lethargy and unleashed a slew of reforms that include a steep rise in heavily subsidised diesel price, limit on cooking gas cylinders at a subsidised price to consumers and the nod to foreign direct investment (FDI) in sectors such as aviation and multi--brand retail to rein in India’s fiscal deficit and to boost investments. The reform measures, announced on Friday, led the rupee to appreciate by 1.1% from Rs54.3/$ to Rs53.7/$ on hopes of more inflows in the near future. There is no doubt that reforms will have a positive impact on India’s economy and the fiscal deficit will be lower than the earlier estimated. But besides tackling the high fiscal deficit, much more needs to be done to address growth and tackle soaring inflation. While FDI in multi-brand retail can solve supply side problems over the medium term, higher level of inflation cannot be avoided in the short term due to a rise in diesel price. Besides domestic inflation, monetary stimulus provided by the ECB (European Central bank) and the US Federal Reserve may tackle short-term global growth problems and financial risks, but certainly exert upward pressure on commodity prices globally. The rise in global commodity prices may fuel core inflation in India, moderating its demand and growth prospects in the near term.

Although we expect medium-term growth prospects to improve on implementation of structural reforms, in the short term, slowing export growth, high inflation, moderating demand will all act as impediments to economic growth. We expect moderation in economic growth with high inflation in FY13.