The RBI Holds Key Interest Rate for Q1 2013-2014 Review

The Reserve Bank of India (RBI) has today kept its key interest rate steady at 7.25%, in line with expectations, due to continued concern with high current account deficit (CAD).

The wholesale price index, India's main inflation gauge, rose 4.86% in June, compared with 4.70% in May. Consumer inflation, which gives more weight to food prices than wholesale data, accelerated to 9.87% in June from 9.31% in the previous month.

The Indian rupee plunged to fresh record low of 61.21 earlier this month, against the US dollar, in trade on sustained dollar demand in the local market.

“A weak rupee exposes the country to external shocks, given the fact that India is largely dependent upon capital inflows to fund its important current account deficit,” said Bundeep Singh Rangar, Chairman of London-based IndusView. “The rupee has fallen about 10% against the dollar since early May, which is pushing up import costs and could feed price pressures in the coming months.”

India’s CAD hit a record $87.8 billion or 4.8% of the gross domestic product (GDP) last fiscal, up from $78.2 billion or 4.2% in the year before.

With crude oil price in the vicinity of $100 or more to a barrel, the government is hoping that a 10%-12% easing of crude oil prices will help the reducing the burden on the CAD. India imported crude oil worth $140 billion in 2011-12. India imports nearly 70% of its crude oil requirement, which has a direct impact on the rising CAD.

The RBI has cut its main lending rate by three quarters of a percentage point in 2013. Industry lobby groups and the government want it to bring the rate further down to support economic growth that slowed to its weakest pace in a decade at 5% in the fiscal year ended on March 31.

“The priority for monetary policy now is to restore stability in the currency market so that macro-financial conditions remain supportive of growth,” said Rangar. “ This strategy can succeed only if reinforced by structural reforms to reduce the CAD and step up savings and investment”.

Overseas investors have pulled out more than $754 million from the Indian debt market in the first week of this month amid concerns over depreciating rupee.

To check imports of non-essential goods that are adding to the already rising Current Account Deficit (CAD), the government has constituted a committee to be headed by Rajat Bhrargav, joint secretary (Budget) in the Ministry of Finance. The committee has been mandated to look into non-essential items in India’s import list so that these could be pruned to ease India’s CAD. Non-essential goods comprise luxury cars, cosmetics, certain exotic foods and beverages, gold, silver and foreign alcohol, among others.