India stuns, keeps rates steady as growth crumbles

MUMBAI Mon Jun 18, 2012 12:56pm EDT

People walk in front of the Reserve Bank of India (RBI) building in Kolkata May 21, 2012. REUTERS/Rupak De Chowdhuri

People walk in front of the Reserve Bank of India (RBI) building in Kolkata May 21, 2012.

Credit: Reuters/Rupak De Chowdhuri

MUMBAI (Reuters) - India's central bank defied widespread calls on Monday to revive the flagging economy with cuts in interest rates and cash reserve minimums at banks, putting the onus on a fractious coalition government to pull the country out of crisis.

The Reserve Bank of India left its policy repo rate at 8 percent and the cash reserve ratio at 4.75 percent, saying a rate cut now could "exacerbate" the country's inflation, the highest among industrialized or BRIC nations.

Bonds, stocks and the rupee fell after the decision and economists scaled back their expectations for future rate cuts. Calls for action from the central bank, including from corporate India, had intensified after economic growth in the March quarter slumped to its weakest annual pace in nine years.

"India is in this deep crisis due to the lack of proper governance," said A. Mahendran, managing director at Godrej Consumer Products Ltd (GOCP.NS). "What happened today is extremely disappointing. We needed the central bank to act because of the current condition of the economy."

After cutting its policy rate by a sharper-than-expected 50 basis points in April, the RBI had been expected to leave rates unchanged in June.

But global and domestic economic conditions had deteriorated sharply since then. Many had expected the central bank to act because a politically hamstrung government is unable to drive reform to revive investment or curtail populist spending, factors that led Fitch Ratings on Monday to cut India's credit rating outlook to negative.

India's benchmark 10-year bond yield rose 9 basis points from before the policy announcement to close at 8.43 percent.

The main BSE index .BSESN erased gains before the decision to end 1.44 percent lower, missing out on a rally in Asian stocks after the election in Greece eased fears for a break up of the European currency bloc.

The rupee, which has slumped to a record low against the dollar as India's economic fortunes waned, tumbled to close at about 55.91 per dollar from around 55.35-55.40 before the rate decision.

"It is to the central bank's credit that it managed to stand up to the pressure from the government and businesses, and remains justifiably concerned about inflation," Rajeev Malik, an economist at CLSA in Singapore, said in a client note.

CRUMBLING BRIC

The RBI made clear it expects the government to do its bit to bring down inflation, which rose in May to 7.55 percent on the wholesale price index, the country's main gauge.

Many analysts argue that structural bottlenecks in the economy are the main reasons inflation in India is so high, so monetary policy can have little effect.

The RBI said on Monday that its "frontloaded" April rate cut "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."

India's Finance Minister Pranab Mukherjee had called for a rate cut and the chairman of State Bank of India (SBI.NS), the country's biggest lender, had sought a 1 percentage point cut in the cash reserve ratio.

"Unless the government takes steps on fiscal adjustment, the RBI is not prepared to cut rates. Based on this document, there's unlikely to be a rate cut in July," said A. Prasanna, economist at ICICI Securities Primary Dealership in Mumbai.

The government has failed to contain its fiscal deficit by enacting reforms or slashing costly subsidies on diesel.

Opposition from partners in the ruling coalition forced India to backtrack in December on a decision to open the retail sector to foreign supermarkets, which had been aimed at bringing investment into supply chains in a country where an estimated one-third of fresh produce is wasted.

INDIA'S CREDIT RISK

The slump in March quarter growth to 5.3 percent was far worse than expected and sparked calls for action to lift an economy that Standard & Poor's and Fitch Ratings have threatened to cut to junk credit status.

Both rate India BBB minus, the lowest investment grade.

"Against the backdrop of persistent inflation pressures and weak public finances, there is an even greater onus on effective government policies and reforms that would ensure India can navigate the turbulent global economic and financial environment and underpin confidence in the long-run growth potential of the Indian economy," said Art Woo, a director at Fitch.

India's chief economic adviser Kaushik Basu said he had expected Fitch's action because there is a "herd mentality" among ratings agencies, while Mukherjee said Fitch "has ignored the recent positive trends in the Indian economy."

April industrial output figures last week suggested little pickup in growth heading into the current quarter.

Rahul Bajoria, regional economist at Barclays in Singapore, said he expects the RBI to cut interest rates by a total of 1 percentage point in the current fiscal year, possibly starting at the central bank's next review on July 31.

"The growth weakness is such that it does call for monetary easing," he said.

A Reuters poll after Monday's RBI decision showed economists had scaled back their rate cut expectations.

Economic policymaking was cast into further uncertainty on Friday when India's ruling Congress party named Mukherjee as its nominee for the largely ceremonial post of president, ending a protracted political drama that had exposed the weakness of the coalition government.

With no obvious successor, Prime Minister Manmohan Singh, 78, is expected to take charge of finance on an interim basis.

"We are very disappointed by the lack of action from any quarter. What is happening here is that you are getting the worst of both worlds, neither getting growth or inflation down," Rajiv Kumar, secretary general of the Federation of Indian Chambers of Commerce and Industry (FICCI) told Reuters.

(Additional reporting by Neha Dasgupta, Nandita Bose, and Shamik Paul in Mumbai and Ross Colvin in New Delhi; Editing by Neil Fullick)

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Comments (1)
CDN_Rebel wrote:
The Indian Central Bank is doing the right thing; frankly it’s OTHER central banks that don’t have the spine to raise rates to where they ought to be – maybe higher 2% across the board. Canada and Australia have been ahead of the curve of the on this issue and their economies continue to look more balanced than others in the G20. It’s high time America, Japan, and the EU did the right thing and raise THEIR OWN rates instead of decrying nations for not lowering theirs.

Jun 18, 2012 4:21am EDT  --  Report as abuse
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