The RBI lowered CRR, the amount of deposits that banks must keep with the central bank, by 25 basis points to 4.25 per cent, a move it said would inject about Rs 17,500 crore into the banking system in order to pre-empt potentially tightening liquidity.
Expectations for a rate cut had grown after Finance Minister P. Chidambaram on Monday outlined a plan to trim the country's hefty fiscal deficit.
The Finance Minister expressed disappointment after the RBI did not cut key rates.
“Growth is as much a challenge as inflation. If the government has to walk alone to face the challenge of growth then we will walk alone.” Mr Chidambaram was referring to the RBI’s stance of reining in inflation before changing key rates to revive flagging growth (read full story).
“Both the government and the RBI share concerns on growth… even RBI has concerns about growth and inflation…only our balance is shifting. If you are asking on the nuances in the FMs statement then I think you should ask him,” RBI governor D. Subbarao said in response.
"As inflation eases further, there will be an opportunity for monetary policy to act in conjunction with fiscal and other measures to mitigate the growth risks and take the economy to a sustained higher growth trajectory," Mr. Subbarao wrote in his quarterly policy review.
Headline wholesale price index inflation rose to 7.8 per cent in September, a 10-month peak, and the RBI said it expects inflation to rise before easing in the final quarter of the fiscal year, which ends in March.
"While risks to this trajectory remain, the baseline scenario suggests a reasonable likelihood of further policy easing in the fourth quarter of 2012-13," Subbarao wrote.
C. Rangarajan, chairman of the Prime Minister’s Economic Advisory Council and former RBI governor, told NDTV Profit: “Yes, it (the RBI) has taken a cautious stance. Inflation is still high, non-food inflation remains sticky. But I do believe that the reduction in CRR is still an indication. It will improve liquidity of banks. RBI believes that if inflation trajectory improves, it will ease policy beginning January 2013. If inflation shows some signs of decline, we need to act and the RBI will change its stance. They (the RBI) have put it very clearly in its guidelines. So we should definitely see easing in monetary policy January-end.”
“Our own estimate at this point is that growth will be close to 6 per cent. This adjustment has happened due to various reasons—monsoon, global environment and lack of pickup in investment sector,” Dr Rangarajan added.
The market had been positioned for a rate cut, said A. Prasanna, economist at ICICI Securities Primary Dealership.
The BSE Sensex fell sharply after the RBI left interest rates unchanged. At 11.46 a.m., the Sensex traded 195 points lower at 18,440 while the broader 50-share National Stock Exchange Nifty traded 68 points lower at 5,598.
"There's a positive that RBI has said there's a likelihood of easing in the January-March quarter. Looks like RBI wants inflation to peak out before cutting rates so we shouldn't expect anything in December. We expect a 50 basis points cut during January-March," Mr Prasanna added.
Investors, companies and the government have been clamouring for a cut to interest rates that have been on hold since April and remain some of the highest among major economies.
"A rate cut in the face of jump in September WPI (Wholesale Price Index), sharp upward revision to historical numbers and recent rebound in the proxy core inflation measure, might have put the bank's inflation-fighting credibility at risk," said Radhika Rao, an economist at Forecast Pte in Singapore.
While economic growth in India has been slowing, inflation has not, and the RBI has been calling on the government to follow through quickly on recent steps to cut its deficit and encourage investment, and to take further such measures.
"Recent policy announcements by the government, which have positively impacted sentiment, need to be translated into effective action to convert sentiment into concrete investment decisions," Dr Subbarao wrote.
Mr Chidambaram on Monday outlined a plan to nearly halve the deficit in just over four years. While he gave few specifics, his announcement at a hastily called news conference was seen as adding pressure on the RBI to cut rates.
The government has unveiled a spate of reforms to bolster investment and rein in its fiscal deficit, including raising the price of subsidised diesel and lifting caps on foreign investment in several industries.
The RBI cut its gross domestic product (GDP) growth forecast for Asia's third-largest economy to 5.8 per cent for the current fiscal year, from 6.5 per cent previously, and increased its projection for headline inflation in March to 7.5 per cent, from 7 per cent earlier.
With inputs from Reuters