UPDATE 2-India central bank holds rates steady, ups inflation forecast
* RBI leaves policy repo rate unchanged at 8 percent
* Cuts GDP growth forecast for fiscal year to 6.5 pct
* Raises WPI inflation outlook for fiscal year to 7 pct
* Cuts minimum bond holding requirement for banks
* Bond yields, swap rates rise after policy, SLR cut
By Suvashree Dey Choudhury and Tony Munroe
MUMBAI, July 31 (Reuters) - India's central bank left interest rates unchanged on Tuesday for the second straight review, showing that bringing down stubbornly high inflation is its top priority even as economic conditions deteriorate.
Underlining its policy dilemma as it faces pressure to reduce rates, the Reserve Bank of India (RBI) cut its economic growth forecast for the fiscal year to March 2013, while at the same time raising its inflation forecast.
The RBI left its policy repo rate at 8 percent and cash reserve ratio for banks at 4.75 percent. The CRR is the share of deposits banks must keep with the RBI.
"In the current circumstances, lowering policy rates will only aggravate inflationary impulses without necessarily stimulating growth," Governor Duvvuri Subbarao wrote in the monetary policy review.
The RBI's primary focus remains inflation control, he added.
The central bank's hard line on rates sits in contrast to many other central banks that are easing credit conditions to try to bolster economies feeling the impact of the euro zone debt crisis.
The stance maintains pressure on Prime Minister Manmohan Singh's government to rein-in populist subsidy spending and take other steps to bolster an economy growing at its weakest pace in almost a decade.
A Reuters poll of 20 economists last week showed all but one expected the RBI to hold rates steady.
Many economists expected the central bank to resume cutting rates only in the second half of the fiscal year, a nd modestly at that.
" Given the inflationary risks and pressures, which I don't see going away, we will continue to see high inflation in the rest of the year," said Abheek Barua, chief economist at HDFC Bank in New Delhi. "In the foreseeable policy horizon, I do not see RBI cutting rates," he said.
Wholesale price inflation remained above 7 percent in June and consumer price inflation was 10 percent. Growth in Asia's third-largest economy slowed to a nine-year low of 5.3 percent in the March quarter.
On Tuesday, the central bank cut its economic growth outlook for the fiscal year that ends in March to 6.5 percent, from the 7.3 percent assumption made in April, putting its outlook closer to that of many private-sector economists.
It also raised its headline inflation projection for March 2013 to 7 percent from 6.5 percent in its April review, further denting market hopes for policy easing in the near term.
The central bank unexpectedly cut the minimum requirement for banks' government bond holdings to 23 percent of deposits from 24 percent, a move to free up liquidity. However, some bankers said the cut was unlikely to spur more lending given worries about deteriorating credit quality in the slowing economy.
The 10-year benchmark bond yield was up 8 basis points at 8.23 percent from its previous close, after rising to as much as 8.28 percent. The 5-year OIS rate rose 10 bps to 7.10 percent, while the 1-year rate rose 4 bps to 7.68 percent.
India's main stock index gave up brief gains and was down 0.4 percent on worries the RBI will not cut rates anytime soon.
"The Reserve Bank of India struck a hawkish stance in its monetary policy statement," said Anubhuti Sahay, an economist at Standard Chartered Bank in Mumbai. "Overall it affirms our view that any rate cut from the RBI is unlikely in rest of 2012."
The RBI cut rates by a steeper-than-expected 50 basis points in April but has kept a hawkish stance since, even in the face of widespread expectations in June it would cut rates again.
"Headline inflation has persisted even as demand has moderated and the pricing power of corporates weakened," Subbarao wrote. "Non-food manufactured products inflation has also not declined to the extent warranted by the growth moderation. This reflects severe supply constraints and entrenchment of inflation expectations."
The RBI's hawkish stance makes it an outlier compared with the likes of China, Brazil and South Korea, which have eased monetary policy in recent weeks to bolster their flagging economies.
The central bank has repeatedly called on the government to take steps to revive investment by implementing long-pending reforms, such as allowing foreign direct investment in the supermarket and airline industries, and to cut populist spending that bloats its fiscal deficit.
On Tuesday, it said an immediate cut in fuel and fertiliser subsidies was needed if the government is to reach its target of cutting subsidies to less than 2 percent of GDP in fiscal 2012/13.
"The path of monetary easing would henceforth be guided by the pace of fiscal reforms with near-term focus on expenditure restructuring," said Shakti Satapathy, fixed income strategist at AK Capital in Mumbai. "A delayed response from the government's end might handicap the quantum of rate cut in the forthcoming policy meet," he said.
The RBI's next rate review is Sept. 17.
India's fiscal deficit for the fiscal year that ended in March was 5.76 percent of GDP, and many economists say its aim to trim that to 5.1 percent for this fiscal year is optimistic.
India has seen a dramatic slide in its economic fortunes compared to the years before the global financial crisis when growth rates were closer to 10 percent.
The rupee has slumped to a record low this year against the dollar and the country's current account, the broadest measure of trade in goods and services with the rest of the world, has hit a record deficit.
Investment has also suffered. A study last week by Indian rating agency Crisil found that capital expenditure by 170 private-sector companies will fall by 35 percent on average in the fiscal year that ends in March.
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