Reserve Bank of India Cuts Interest Rate by 25 Basis Points


Based on an assessment of the current macroeconomic situation, the Reserve Bank of India decided to reduce the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis points from 7.75 percent to 7.5 percent with immediate effect. Consequently, the reverse repo rate under the LAF stands adjusted to 6.5 percent and the marginal standing facility rate and the Bank Rate to 8.5 percent with immediate effect.

Excerpt from the statement by the Reserve Bank of India:

Since the Reserve Bank’s Third Quarter Review of January 2013, global financial market conditions have improved, but global economic activity has weakened. On the domestic front too, growth has decelerated significantly, even as inflation remains at a level which is not conducive for sustained economic growth. Although there has been notable softening of non-food manufactured products inflation, food inflation remains high, driving a wedge between wholesale price and consumer price inflation, and is exacerbating the challenge for monetary management in anchoring inflationary expectations.

There are several risks to the global outlook. The impact of sequestration in the US on the global economy is likely to be muted in view of legislation initiated to avert the debt ceiling. Nevertheless, lead indicators point to sluggish global growth. On the domestic front, the key macroeconomic priorities are to raise the growth rate, restrain inflation pressures and mitigate the vulnerability of the external sector. These are briefly addressed in the following paragraphs.
 
The Central Statistics Office has projected GDP growth for 2012-13 of 5.0 per cent, lower than the Reserve Bank’s baseline projection of 5.5 per cent set out in the Third Quarter Review, reflecting slower than expected growth in both industry and services. Key to reinvigorating growth is accelerating investment. The government has a critical role to play in this regard by remaining committed to fiscal consolidation, easing the supply bottlenecks and improving governance surrounding project implementation.
 
On the inflation front, some softening of global commodity prices and lower pricing power of corporates domestically is moderating non-food manufactured products inflation. However, the unrelenting rise in food inflation is keeping headline wholesale price inflation above the threshold level and consumer price inflation in double digits. On the external sector front, the key challenge is to reduce the CAD, which is well above the sustainable threshold.  This adjustment, requiring as it does, measures to improve the competitiveness of exports and wean away demand for unproductive imports, will inevitably take time.
 
The foremost challenge for returning the economy to a high growth trajectory is to revive investment. A competitive interest rate is necessary for this, but not sufficient. Sufficiency conditions include bridging the supply constraints, staying the course on fiscal consolidation, both in terms of quantity and quality, and improving governance.

RBI | Nuno Fontes | nuno@tradingeconomics.com
3/19/2013 8:47:02 AM