Asserting that easing monetary policy could worsen inflationary pressures, the Reserve Bank of India (RBI), on Monday, kept the indicative short-term policy rate (Repo rate) and the Cash Reserve Ratio (CRR) unchanged. While doing so, the apex bank has ignored widespread demand and expectations for a rate cut to revive growth.

The RBI kept the Repo rate unchanged at 8 per cent and the CRR at 4.75 per cent. Repo rate is the rate at which banks borrow money from the central bank.

“Further reduction in the policy interest rate at this juncture, rather than supporting growth, could exacerbate inflationary pressures. Factors other than interest rates are contributing more significantly to the growth slowdown,” the RBI said.

“Estimates suggest that real effective bank lending interest rates, though positive, remain comparatively lower than the levels seen during the high growth phase of 2003-08,” it pointed out in its First Quarter Mid-Term Review of Monetary Policy of 2012-13.

However, the RBI has increased the limit of export credit refinance from 15 per cent of outstanding export credit of banks to 50 per cent to augment liquidity and encourage banks to increase credit flow to the export sector. The RBI said that this would “potentially release additionally liquidity of over Rs.30,000 crore, equivalent to about 50 basis point reduction in the CRR.”

Markets and industry were expecting a rate cut of 25-50 basis points, which, they believed, would stimulate the lacklustre manufacturing growth. The growth of 5.3 per cent recorded in the last quarter of 2011-12 was the weakest annual growth in nine years though for the year as a whole it was 6.5 per cent. The index of industrial production (IIP) increased by just 0.1 per cent in April 2012. The industry was clamouring for a rate cut even as global credit rating agencies were warning India that its investment grade ratings could be reduced.

The RBI had frontloaded the policy rate reduction last April with a cut of 50 basis points. “This decision was based on the premise that the process of fiscal consolidation, critical for inflation management, would get under way, along with other supply-side initiatives,” the RBI said. The apex bank now believes that this has not happened.

In his annual policy announcement last April, the RBI Governor D. Subbarao had said that if subsidies weren’t contained as indicated in the Union Budget (2012-13), “demand pressures will persist, and will further reduce whatever space there is for monetary easing.”

“Our assessment of the current growth-inflation dynamics is that there are several factors responsible for the slowdown in activity, particularly in investment, with the role of interest rates being relatively small,” the RBI said.

The apex bank pointed out that consumer price index (CPI) inflation, excluding food and fuel, was also in double digit, suggesting that “moderation in wholesale price inflation has not transmitted to the retail level.”

Reminding the government that subsidies were a major issue, the RBI said that in the absence of pass-through from international crude oil prices to domestic prices, consumption of petroleum products remained strong, distorting price signals and preventing the much- needed adjustment in aggregate demand. “The consequent subsidy burden on the government is crowding out public investment at a time when reviving investment, both public and private, is a critical imperative,” the apex bank added. “The widening current account deficit (CAD), despite the slowdown in growth, is symptomatic of demand-supply imbalances, and a pointer to the urgent need to resolve the supply bottlenecks,” it added.

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