The economy faces the ‘twin deficit’ risk, says Governor Subbarao
The Reserve Bank of India (RBI), on Tuesday, kept the key indicative policy rates unchanged while it cut the gross domestic product (GDP) forecast for the current financial year from 7.3 per cent to 6.5 per cent and raised the inflation forecast from 6.5 per cent to 7 per cent.
However, the RBI cut the Statutory Liquidity Ratio (SLR) by one percentage point from 24 per cent to 23 per cent which is expected to provide liquidity of around Rs.60,000 crore.
“Even as our growth is slowing in line with the rest of the world, our inflation continues to be high…. the primary focus of monetary policy remains inflation control,” said D. Subbarao, Governor, RBI, while addressing a press conference after meeting bankers as part of its first quarter review of the Monetary Policy 2012-13.
In the present circumstances, said Dr. Subbarao, “lowering policy rates will only aggravate inflationary impulses without necessarily stimulating growth.”
The RBI left interest rates unchanged for the second straight review. It kept the Repo rate unchanged at 8 per cent, and the Cash Reserve Ratio (CRR) at 4.75 per cent. Repo rate is the rate at which banks borrow money from the central bank. CRR is the portion of deposits banks have to keep with the central bank in cash.
This time around, markets and industry were almost certain that the RBI was unlikely to cut rates.
The RBI had frontloaded the policy rate reduction in April last with a cut of 50 basis points. Since then, the rates remained the same.
However, in a move to provide more liquidity in the system, the central bank has reduced the Statutory Liquidity Ratio (SLR) from 24 per cent to 23 per cent with effect from August 11. SLR is the amount of liquid assets or securities that commercial banks must maintain as reserves other than the cash.
Liquidity conditions play an important role in the transmission of monetary policy signals. “Although the liquidity situation has eased significantly in the recent period, the reduction of SLR is expected to ensure that liquidity pressures do not constrain the flow of credit to the productive sectors of the economy. This will allow banks to shift their portfolio in favour of the private sector,” said Dr. Subbarao.
The RBI governor said that the monsoon had been deficient and uneven so far.
“This will have an adverse impact on food inflation. He also said that international crude prices remained elevated, and, on top of that, the rupee depreciation had added to import prices, putting upward pressure on domestic fuel prices.
“The adjustment in domestic prices of petroleum products to international price changes is still incomplete. Going forward, the embedded risks of suppressed inflation could also impact fuel prices in India.”
At current levels of current account and fiscal deficits, the economy faced the “twin deficit” risk, said Dr. Subbarao. “Financing the fiscal deficit from domestic savings crowds out private investment, thus lowering growth prospects. This, in turn, deters capital inflows, making it more difficult to finance the current account deficit. Failure to narrow the twin deficits with appropriate policy actions will threaten both macro-economic stability and growth sustainability.”