RBI Does Not Blink On Repo Rate, CRR

The Indian markets received a high voltage shock today when the apex bank of India, RBI kept the Repo rate and the cash reserve ratio (CRR) unchanged at the previous levels. The equity markets, which were expecting a rate cut, have declined by 1.2% on this.

The CRR of scheduled banks has been left unchanged at 4.75%, while the Repo rate is unchanged at 8% under the liquidity adjustment facility (LAF).

This has come to a stark contrast to the expectations of most of the analysts, economists, industrialists and experts, who diferred in their opinions on the quantum of the rate cut, but were unanimously in agreement that there will be a rate cut. We, at DSIJ, had expected that the RBI will not cut the rates in our previous article titled Will The RBI Maintain Status Quo For The Next One Quarter? (dated 6/7/2012).

In Apr 2012, the RBI had made the first cut of 50 bps in the Repo rate. This time, the central banker has made it clear that inflation is the key concern. According to the RBI, there are several factors responsible for the current scenario of growth-inflation. The slowdown in investments is least affected by the interest rates. In fact, the bank believes that a further reduction in policy interest rates could worsen the inflationary pressures rather than supporting growth.

RBI’s remarks and its policy stance come after the recent inflation data, which showed that inflation rose to 7.55% in May 2012 from the Apr 2012 figure of 7.23%. Besides, the government also upwardly revised the Mar 2012 inflation figure to 7.69% from the earlier estimate of 6.89%. Higher inflation has been the top priority for the central bank, and hence, it has maintained its original stand of not pumping up additional liquidity in the markets. This was also the reason for the RBI going ahead with several successive interest rate hikes in past two calendar years.

The markets believed that an interest rate cut was in the offing mainly due to lower GDP and IIP growth. The GDP growth rate for the Mar 2012 quarter was at a 9-year low of 5.3%. In fact, the markets firmly believed that the RBI would cut the Repo rate by at least 25-50 bps after the industrial output for Apr 2012 was almost flat at 0.1%. Another factor that pushed for a rate cut was the drop in global oil prices to below US$ 100 a barrel from the earlier level of US$ 120 a barrel. Based on these, the markets were seen discounting the 25 bps repo rate cut. We expect that they will now remain under heavy pressure following the high interest rates, high inflation and flat-to-negative growth in the industrial output.

In its guidance, the central bank has said that the growth-inflation dynamic will continue to influence its stance on interest rates. It has said that though core inflation has moderated, the headline and retail inflation rates are rising, and future actions will depend on the assessment of external and domestic developments that contribute to lowering inflation risks. For liquidity management, the RBI will continue its open market operations (OMO) as and when required.

We now expect the RBI to keep the rates unchanged for one quarter. If inflation comes down during this period, then we may see a rate cut.

Table : 2012 - Inflation and IIP numbers