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RBI policy review: Investors upset with no-action; no rate change, nor any timeline for easing liquidity

RBI lowered its economic growth rate forecast to 5.5% and warned that inflation could rear its head again.

ET Bureau|
Updated: Jul 31, 2013, 01.26 AM IST
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RBI lowered its economic growth rate forecast to 5.5% and warned that inflation could rear its head again.
RBI lowered its economic growth rate forecast to 5.5% and warned that inflation could rear its head again.

MUMBAI: Reserve Bank Governor DuvvuriSubbarao left rates unchanged as expected and scaled down economic growth projections in his swan song monetary policy announcement whose hardline tone presaged more pain for the economy and, in the process, roiled markets.

Subbarao, who retires in September after five years at the helm of the central bank, on Tuesday refused to signal a timeline for rolling back the recent liquidity squeeze undertaken to defend a sliding rupee, and warned that these actions had consequences. "We are determined to control volatility in the exchange rate," he told a news conference after unveiling the monetary policy review.

“There will be consequences for this. There will be pain in the economy. Somebody will have to bear the cost for this. Those costs are inevitable and unavoidable.” Pushing two years of growth in flation rhetoric to the back seat, the governor forecast a grim picture for the economy if measures to correct external imbalances did not come forth.

Investors reacted with the wallets, sending bond and stock prices down. The rupee too ended lower than what it was on July 15, the day RBI tightened liquidity by stealth and raised interest rates. The central bank lowered its economic growth rate forecast to 5.5% and warned that inflation could rear its head again as producers pass on higher costs due to the sliding rupee.

RBI lowered its economic growth rate forecast to 5.5% and warned that inflation could rear its head again.
International financial markets are also a threat to financial stability, it said. Subbarao's20th quarterly monetary policy review saw no change in key rates — the repo rate, or the rate at which RBI lends to banks — was left unchanged as were banks' cash reserve requirement, statutory liquidity ratio and marginal standing facility. In the past two weeks, RBI has capped banks’ borrowing at Rs 37,000 crore and raised penal lending rates under the marginal lending facility to 10.25% as part of its attempt to arrest a steep slide in the currency.

Although repo rate has been left untouched at 7.25%, RBI's actions have led to short-term rates on commercial paper and bonds surging, raising borrowing costs for companies. The governor, who has been cautioning about the unmanageable level of current account deficit — the excess of spending overseas than earnings — and lack of reforms by the government to ease supply-side pressures, again hinted that the government has to do more.

But he offered little by way of comfort on when the tight measures would be rolled back. “We will persist with these measures and implement them consistently in order to achieve the intended results,” said Subbarao.

“Rates will come down in future but not until such time as volatility in the exchange rate is contained.” The rupee fell 1.8% to 60.48 to the US dollar and the yield on 10-year benchmark government bonds rose 9 basis points to 8.25%. Bond prices and yields move in opposite direction. The BSE Sensex fell 1.25% to 19,384.

Analysts said the economy faced headwinds and the months ahead looked tough. “There is a non-trivial risk that the concerns related to Fed tapering could continue to weigh on emerging market capital flows for the remainder of the year,” said Leif Eskesen, chief economist for India & ASEAN at HSBC. “This would make it difficult for RBI to roll back the liquidity measures as quickly as it may hope, especially if the current account deficit has not moved in the right direction in the meantime.”
 


The rupee touched a life low of 61.21 to the US dollar on July 8 after a sustained selloff in domestic bonds by global portfolio investors. That was triggered by Federal Reserve Chairman Ben Bernanke hinting at tapering off the $85-billion monthly bond purchases that flooded emerging markets with dollars. There is a risk this tapering could be announced sometime this year.

If it happens, it could affect capital flows and shut off the tap on the main source of India’s current account deficit funding, leaving the government with little choice other than curbing imports or the time-consuming option of raising exports.

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