IndusView, Monday September 17 (London): The Reserve Bank of India (RBI) today kept interest rates unchanged, despite last-minute hopes for a reduction in the wake of policy changes announced by India’s government last Friday. It did, however, reduce the core reserve ratio requirement of Indian banks by 0.25% that’s expected to increase lending as new liquidity is ushered into the banking system.
The RBI left its benchmark repo rate at 8% even as it cut the cash reserve ratio for banks to 4.50% from 4.75% that's could see as much as $3 billion available in new credit by banks. Wholesale price inflation rose to 7.55% in August and consumer price inflation was about 10%.
"India’s central bank continues to use monetary policy to fight inflation even at the cost of growth,” said Bundeep Singh Rangar, Chairman of London based advisory firm IndusView. “While the diesel price increase announced by the government was a step in the right direction to cut the budget deficit, a key requirement by the RBI for it to cut rates, ironically, it also could have an inflationary effect that is the RBI’s key enemy.”
“Inflation may rise due to the first increase in diesel prices in 14 months and a rise in the price of commodities as the U.S. steps up monetary easing,” added Rangar.
In the biggest economic policy push, more than halfway through Prime Minister Manmohan Singh’s second term, The Indian Prime Minister introduced the long awaited reforms allowing foreign direct investments (FDI) in multi-branded retail and aviation sectors on Friday. Proposals to allow overseas retailers like Wal-Mart Stores Inc. and Carrefour SA to own 51% of supermarket chains, shelved last year after alliance partners threatened to revolt, have been reinforced now.
India has also announced a 14% rise in the price of diesel, the first increase in more than one year, in an attempt to cut the country's budget deficit.
“The RBI has been reluctant to ease rates without the government doing its part to fix its budget deficit,” said Rangar. “The diesel rate hike was the minimum needed to get the RBI to act.”
The RBI increased interest rates a staggering 13 times since March 2010 in one of the most aggressive monetary tightening by any major central bank around the world. It succeeded in bringing down inflation to about 7% from a high of 10% in Sept. 2011. Still, inflation based on the Wholesale Price Index (WPI) increased to 7.55% in August from 6.87% in July. That’s above the RBI's 5%-6% target.
The RBI’s focus on inflation is despite slowing GDP growth that slipped to 5.3% in the fourth quarter of 2011-12, the lowest in nearly nine years, following poor performance of the manufacturing and farm sectors. As a result, GDP growth for the full year 2011-12 was down to 6.5% from 8.4% in 2010-11 with dismal predictions for 2012-13 at annual GDP growth below 6%.
The government also allowed foreign airlines to buy stakes of up to 49% in local carriers, a much-awaited policy move that provides a potential lifeline to the country's debt-laden airlines such as Kingfisher and open fresh sources of funding for the likes of SpiceJet Ltd, Go Airlines Ltd and Jet Airways Ltd.
The move had been strongly opposed by tens of thousands of small businesses and corner-shops, which fear they will be put out of business. But this latest move has already been welcomed by economists and industry, who say it will transform the way Indians shop and boost the country's flagging economy.
According to the RBI, maintaining interest rates alone won’t suffice to reignite the investment cycle. With limited fiscal and monetary space available for direct stimulus to domestic growth, the government also needs to reduce spending by cutting subsidies and allocate resources instead to boost public capital expenditure.
The RBI added that structural impediments impacting business confidence needed to be addressed immediately and has previously listed issues for the Manmohan Singh government to take care of such as mining and infrastructure to stimulate growth.
Prime Minister Manmohan Singh is the only Prime Minister since India’s founding Prime Minister Jawahar Lal Nehru to return to power after a full five-year term in office. Singh’s liberal economic policies have rolled back much of Nehru’s socialist economic construct that saw dismal growth rates for nearly five decades of post-independent India.