Pause pricks bubble of hope
- RBI drops broad hint of policy reversal

OUR SPECIAL CORRESPONDENT

Mumbai, Dec. 16: The Reserve Bank of India today hit the pause button on its 21-month rate tightening cycle and sent out a clear signal that it could trim its policy interest rates in the coming months if the economy continues to wobble.

It's the first time that the RBI has talked about reversing its tight monetary policy. Other emerging nations facing a similar predicament, such as Brazil, Indonesia, Israel and Thailand, have slashed their benchmark interest rates to bolster their faltering economies in recent months.

"From this point on, policy actions are likely to reverse the cycle, responding to the risks to growth," the RBI said today after its policymakers met for its third mid-quarter policy review this year.

On rate cut, RBI governor Duvvuri Subbarao said, "I cannot really speculate on when we might start cutting rates, but that is an event, an action that is on the way forward."

The guidance by the central bank on interest rates should offer some relief to the harried home loan borrower and corporate India.

In its second-quarter monetary policy review on October 25, the RBI had indicated that its 25-basis-point hike in the repo to 8.5 per cent on that day would be the last rate increase this year unless something went horribly wrong. It came good on that promise today.

"This is definitely the end of the rate tightening cycle. There is no scope for further hikes," Rupa Rege Nitsure, chief economist at Bank of Baroda, told The Telegraph.

But faced with a double whammy on economic growth — second-quarter GDP growth slid to 6.9 per cent and industrial growth shrank 5.1 per cent in October, a contraction for the first time in over two years — the RBI had to shift its focus from inflation to growth. After 13 rate increases since March 2010, the central bank has failed to quell inflation that stubbornly remains above 9 per cent.

Growth risks

The double blow to growth and a rising clamour from industry to address the problem finally forced the central bank to admit that economic growth had started to decelerate.

"The downside risks to the Reserve Bank's growth projection…have increased significantly," it added.

In October, the RBI had projected GDP growth of 7.6 per cent in the fiscal year that ends on March 31. Since then, the finance ministry has trimmed its own forecast to 7.5 per cent.

But even as he changed the tenor of his talk, the RBI governor decided not to announce any policy measure.

So, he left the repo rate and the cash reserve ratio (CRR) unchanged at 8.5 per cent and 6 per cent, respectively.

The repo is the rate at which it provides liquidity to banks, while CRR represents the proportion of deposits that banks must maintain with the RBI.

"The tone of the RBI is relatively soft and the indications are that in January 2012 it may actually consider a cut in CRR," said Kislay Kanth, senior director (research) at MAPE Securities.

Subbarao indicated that the bogey of inflation still hovered in the background even though month-on-month and the three-month moving average rolling quarterly inflation rate showed continuing signs of moderation.

The rising fiscal deficit remained a source of worry. "The likely slippage in this year's fiscal deficit has inflationary implications," the RBI added.

January review

The central bank said it would make a "formal numerical assessment of its growth and inflation projections for 2011-12" in the third-quarter review on January 24. Observers feel the central bank can cut its GDP growth estimate for the year at the January review.

"It must be emphasised that inflation risks remain high and inflation could quickly recur as a result of both supply and demand forces. Also, the rupee remains under stress," the RBI said.

Nitsure said the precise moment when the RBI would begin to cut rates was uncertain as inflation would remain the critical anchoring point for it to happen.

Economists at Yes Bank reckon that while elevated levels of inflation will see the RBI maintaining status quo on interest rates in its January policy review, it will start cutting policy rates from March.

According to the RBI, inflationary pressures are likely to abate in the coming months because of growth deceleration and softening food inflation.