Reserve Bank of India Cuts Rates To Boost Growth, Emulating China

Borrowing a leaf or two from Chinese policy makers to spur economic growth, the Reserve Bank of India (RBI) decided to reduce its key interest rate to 7.75% from 8% for the first time in nine months as well as reduce the amount of cash Indian banks must set aside as reserves.

India’s central bank reduced the cash reserve ratio (CRR), or the money commercial banks have to retain in the form of liquid assets in proportion to their deposits, from 4.25% to 4%. The move is expected to provide $3.35 billion of extra cash for them to lend. Last November, China cut the amount of cash that banks must set aside as reserves for the first time since 2008. Its key interest rate was dropped more than 50 basis points last year to 6% from 2011. Its GDP forecast is now at 8.1% for 2013 compared with 7.7% in 2012.

The RBI lowered the growth projection for the current fiscal to 5.5% from 5.6% projected earlier. It has also cut the growth forecast for the next financial year to 6.5% from 6.6%. The International Monetary Fund (IMF) lowered its projections for India’s economic growth to 4.5% for the 2012 calendar year from its earlier estimate of 4.9%. The RBI’s last cut on April 17, 2012 by 50 basis points, in an effort to boost growth, has yet to show results.

“Spurring growth in is back on the central bank’s agenda that had been obsessed with fighting inflation and controlling prices for the past two years,” said Bundeep Singh Rangar, Chairman of London-based advisory firm IndusView. “The rate cut and other reforms should act as turnaround catalysts as India hopes to emulate China whose growth is back on track as a result of its central bank’s policies.”

The RBI said that it has limited room for easing monetary policy to support growth as it is worried about the wide fiscal and current account gaps, on top of a likelihood that inflation may not ease significantly next fiscal year.

Inflation based on wholesale prices declined marginally to 7.18% in December even though rates of food items like rice, wheat, pulses and potato showed a rise. It is still, however, above the RBI's 5%-6% target. India’s inflation rate last month compares with 6.5% in Brazil, 6.1% in Russia and China’s 4.1%.

The Wholesale Price Index (WPI) was 7.24% in November and 7.32% in October. Industrial output growth rate had contracted by 0.1% in November, from a robust 8.3% in October.

“The rate cut was much needed as the economic growth is moderating and the industrial production is decelerating,” said Rangar. Government data released January 11 showed that India’s industrial production contracted 0.1% from a year earlier in November, the sixth time it has shrunk in nine months.

Notwithstanding the challenges on macroeconomic front, Indian business owners’ confidence witnessed an improvement for the second consecutive quarter, owing to the government's reforms push and easing inflation, says research firm Dun & Bradstreet.

For the first quarter of this calendar year, the Dun & Bradstreet Composite Business Optimism Index stood at 146.8, registering an increase of 4.3% compared to 140.8 in the fourth quarter of last year. On a year-on-year basis, however, the optimism for the coming three months still represent a decline of 6% compared to corresponding quarter last year.

The government has recently taken a number of reform initiatives such as opening the multi-brand retail and aviation sectors to foreign direct investment (FDI), hiking diesel prices and capping the number of subsidized liquefied petroleum gas (LPG) cylinders. It also decided to raise the FDI cap in insurance to 49% from 26%.