Repo is the rate of interest at which banks borrow money from RBI. This is a reference rate used by banks to lend to their customers like companies and individuals. CRR is the portion of deposits that banks must keep with the central bank. The central bank last cut its repo rate in April, when it reduced the policy rate by a larger-than-expected 50 basis points. One basis point is a hundredth of a percentage point.
Making it clear that it would continue to keep an eye on inflation before taking any decisions, the RBI said in its forward guidance that the evolving growth-inflation dynamic would continue to influence its decision-making.
"Future actions will depend on a continuing assessment of external and domestic developments that contribute to lowering inflation risks," the RBI said in its statement.
It also ruled out that high interest ratesonyl had a small role to play in the growth slowdown, as India Inc has suggested. "Our assessment of the current growth-inflation dynamic is that there are several factors responsible for the slowdown in activity, particularly in investment, with the role of interest rates being relatively small," the RBI statement said.
"Consequently, further reduction in the policy interest rate at this juncture, rather than supporting growth, could exacerbate inflationary pressures," it said.
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The banking regulator also made it clear that the government will need to follow the path of fiscal consolidation. In its annual policy in April, the RBI had identified the fiscal deficit as one of the risks it would watch, saying that any slippage would have implications for inflation.
"The Reserve Bank had frontloaded the policy rate reduction in April with a cut of 50 basis points. This decision was based on the premise that the process of fiscal consolidation critical for inflation management would get under way, along with other supply-side initiatives," the RBI said on Monday, suggesting that it was linking monetary policy to discipline in fiscal policy. The government has said that fiscal deficit will likely be at 5.1 per cent of gross domestic product in financial year 2013.
The Bombay Stock Exchange reflected the RBI's stance almost immediately -- the benchmark Senses fell more than 100 points. The yield on India's benchmark 10-year bond rose to 8.08 per cent versus 8.04. The rupee, which has taken battering over the past few weeks, fell to 55.57 against the dollar after having touched a day's high of 55.27 to earlier in the day.
"The RBI clearly surprised the market by not cutting either CRR or the repo rates. However, we do think that the RBI has changed tack on liquidity, i.e. it is now willing to provide more liquidity comfort to banks than before," said Kumar Rachapudi, Singapore-based fixed income strategist for Barclay's Capital.
Finance Minister Pranab Mukherjee, who will demit office later this month to run for President, also said that inflation likely played a role in the RBI's decision, and that it was "not necessary" for the central bank to consult the Ministry for a mid-quarter policy review.
"Perhaps the inflation figures, WPI inflation in May, which was 7.56, there has been some marginal increase in CPI (Consumer Price Index) which might have weighed their decision making," he said shortly after the RBI's decision was announced.
Wholesale inflation for inflation grew to 7.55 per cent, up from 7.23 per cent in April, and the highest among industrialised countries and the BRIC group of Brazil, Russia, India and China. The rate of retail inflation, as measured by the Consumer Price Index, inched up to 10.36 per cent from 10.26 per cent in April. Retail food inflation also rose to 10.66 per cent from 10.18 per cent on a monthly basis.
The government also revised its March inflation rate to 7.69 per cent from the earlier estimate of 6.89. Core inflation, though, has stayed under 5 per cent, giving some comfort to monetary policy makers.
In a Thomson Reuters poll, a majority of economists said that the RBI could cut rates by 25 basis points but would keep the CRR unchanged.
Separately, the central bank enhanced the eligible limit of the Export Credit Refinance (ECR) facility for scheduled banks (excluding RRBs) from 15 per cent of the outstanding export credit eligible for refinance to 50 per cent. The move will be effective in the fortnight beginning June 30.
"This will provide additional liquidity support to banks of over Rs 300 billion," the RBI said in a statement.
Falling manufacturing output and slow growth has pushed Reserve Bank of India to cut benchmark rates that could reduce cost of borrowing for corporates and individuals -- it cut its key policy rate on April 18 by a surprisingly high 50 basis points to 8.0 per cent.
GDP growth came in at 6.5 per cent for fiscal 2012, while growth for the March quarter fell to a nine-year low of 5.3 per cent, prompting calls for the RBI to cut its interest rate. Industrial output for April grew a meager 0.1 per cent, a clear sign of lower investments. A drop in global oil prices to below $100 a barrel from $120 a barrel in mid-April added to expectations for rate cuts.
The central bank, however, has made it clear that inflation and liquidity supply is its focus at the current time. It also noted that it had 'frontloaded the policy rate reduction in April". In fact, the RBI had at the time made it clear that there was little room for further rate cuts.
Earlier, RBI Deputy Governor Subir Gokarn had said that falling global oil prices, declining core inflation and sluggish growth gives room to cut rates, although he added that high food prices and a wide fiscal deficit add to inflationary pressures. Deputy Governor K C Chakrabarty, however, had said that lower growth was not because of the high interest rate regime that the RBI has imposed to keep inflation under check.
Commerce Minister Anand Sharma, however, called the RBI’s decision “disappointing”.
“Inflation is because of food articles, no manufacturing inflation as of now,” he said, adding that he would write to the Finance Minister and the RBI on “higher rates hurting industrial activity”.