Rajan surprises with status quo policy; to watch inflation

The short-term lending rate was kept unchanged at 7.75 percent, while the cash reserve ratio (CRR) remained at 4 percent.

PTI| Last Updated: Dec 18, 2013, 19:41 PM IST

Mumbai: Belying market apprehensions, Reserve Bank Governor Raghuram Rajan on Wednesday sprang a surprise leaving key rates unchanged to back growth but warned that they may be hiked if inflation does not subside.

Rajan's reading of declining inflation led to maintaining the status quo on the repo rate at 7.75 percent and cash reserve ratio (CRR) at 4 percent, a move that cheered both the capital market and India Inc.

"If the expected softening of food inflation does not materialise and translate into a significant reduction in headline inflation...Or if inflation excluding food and fuel does not fall, the Reserve Bank will act, including on off-policy dates," he said after unveiling the Mid-Quarter Monetary Policy Review.

The next review is due on January 28.

Rajan, who had earlier surprised the markets by raising rates, said vegetable prices which were primarily responsible for inflation soaring to a 14-month high of 7.52 percent in November, are "turning down sharply" and expected economic growth to be better in the second half of the fiscal.

The decision to keep rates unchanged will be a breather for the industry and retail borrowers in particular as the markets had expected another 0.25 percent hike in the short-term lending rate that could have raised EMIs for home, auto and other loans.

SBI Chairperson Arundhati Bhattacharya said the bank would not contemplate cutting deposit rates as "it really hurts the depositors and we would not like to do that. Our rates are still higher than what it was on July 15, I see no immediate rate cut."

Commenting on the policy, Prime Minister's Economic Advisory Council (PMEAC) Chairman C Rangarajan said: "It is a difficult balancing act...I certainly think that the priority to RBI is price stability and therefore they should keep continuous watch on what is happening to inflation."

Rajan said economic growth is set to improve in the second half of this financial year on expansion in the agriculture sector, exports and movement in stalled projects.

Factory output shrank 1.8 percent in October, the first contraction in the Index of Industrial Production (IIP) in four months.

Shifting his stance from inflation management, Rajan said continuing weakness in economic growth was the main driver of his policy action.

"We are happy that RBI has taken cognisance of the weak state of the industrial economy and hope that the next move will be in the direction of lowering of policy rates. At this juncture, we certainly need to push all buttons to safeguard growth and revive investor sentiment," Ficci President Naina Lal Kidwai said.

Enthused by the policy announcement, the stock markets reacted positively. The benchmark BSE Sensex climbed for the first time in seven days and closed at 20,859.86, up 247.72 points.

Bank of India Chairperson V R Iyer concurred that there is no room to cut lending and deposit rates at the moment.

"Inflation is very high and there is hardly any scope for us to reduce the interest rate on deposits, at least at the year end. Absolutely, we will not be able to do that at the moment. But the bulk deposit rate we will be able to take a call and reduce the rate," Iyer said.

"Immediately, there will not be any room for us to reduce the base rate," she added.

On inflation, Rajan said, "There are indications that vegetable prices may be turning down sharply, although trading mark-ups could impede the full pass-through into retail inflation."

The other respite for the RBI is the improvement in the current account deficit (CAD), which narrowed to 1.2 percent of GDP in the second quarter after a steep decline in gold imports. The CAD was 4.9 percent of GDP in the first quarter (April-June).

"I would be much happier if we had the kind of CAD we have without significant curbs on anything, including gold. We should aim to have a CAD without any distortions, removing the incentives for smuggling, that is what we will be working for," Rajan said.