* Policy repo rate cut by 25 bps to 7.75 pct, as expected
* Inflation seen staying around current level into 2013/14
* Bonds, stocks little changed as rate cut move priced in
* Finance minister welcomes cut, eyes on budget in February
By Suvashree Dey Choudhury and Aradhana Aravindan
MUMBAI, Jan 29 (Reuters) - India’s central bank lowered its key policy rate for the first time in nine months on Tuesday, but struck a cautious note on further easing as it waits to see how the government’s upcoming budget aims to bring a bloated fiscal deficit under control.
The Reserve Bank of India cut the policy repo rate by 25 basis points (bps) to 7.75 percent to help support an economy set to post its slowest annual growth rate in a decade.
The RBI revised its GDP growth forecast for Asia’s third-largest economy to 5.5 percent from 5.8 percent for the fiscal year ending in March, a sharp come down for an economy that was running at near double-digit growth before the Lehman Brothers crisis.
Though respectable by other standards, the growth rate is too slow for an economy trying to support hundreds of millions of poor people, and is a worry for the ruling Congress party as it heads towards an election next year.
“It is now critical to arrest the loss of growth momentum without endangering external stability,” the RBI said in its policy review.
But it went on to list constraints, notably worryingly high current account and fiscal deficits, and the risk that inflation could flare again.
Governor Duvvuri Subbarao told a news conference that if inflation and the current account deficit moderated by more than expected there would be room to ease monetary policy.
“The message that we are trying to give is that as much as there is some space, it going to be quite limited, and we are going to use it with a lot of judgment on timing and quantum,” Subbarao said.
Analysts were split on their outlook for rates, with some unprepared to forecast beyond another quarter percentage point cut, whereas Credit Suisse, in a note to clients, stood by its forecast that the repo rate will come down another 100 basis points, though perhaps not by July, as it had expected earlier.
Eyes will now fall on Finance Minister P. Chidambaram’s annual budget statement due in late February, to see how the government plans to put its finances in order.
Speaking to Reuters Television in London, Chidambaram acknowledged that the “ball was in the government’s court” to revive growth. He pledged to present a “responsible” budget.
“I welcome the decision (the RBI governor) has taken today. Going forward, if inflation moderates, I think he will do more,” Chidambaram said.
He added: “More has to be done on the fiscal side (to) contain inflation and revive growth.”
Some analysts predicted the RBI would respond to the budget by cutting another quarter percentage point in March.
“The fiscal side will be critical,” Jonathan Cavenagh, a strategist at Westpac Banking Corporation in Singapore, commented. “If the RBI feels the government’s reform push is slipping, rate cuts will be put on the back burner.”
The size of the latest cut was in line with forecasts in a Reuters poll of analysts this month. The central bank gave guidance in October that it could reduce rates during the January-March quarter, and Indian bond and stock markets were largely unmoved as dealers had already priced in the move.
But the RBI unexpectedly also reduced the cash reserve ratio (CRR), the share of deposits that banks must keep with the central bank, by 25 bps to 4.00 percent, which will infuse an extra 180 billion rupees ($3.4 billion) into the banking system.
India’s headline inflation rate moderated to a three-year low of 7.18 percent in December, and the central bank said there was likelihood that inflation would remain range-bound around current levels entering the 2013/14 fiscal year starting April.
The RBI lowered its projection for headline inflation in March to 6.8 percent from 7.5 percent earlier.
“This provides space, albeit limited, for monetary policy to give greater emphasis to growth risks,” the central bank said.
Montek Singh Ahluwalia, deputy chairman of India’s Planning Commission, regarded the RBI’s easing as an endorsement of steps taken by the government to tackle its deficit.
“I think what it signals is the RBI feels that the government has taken a number of steps which gives the fiscal space needed for monetary policy to support growth,” Ahluwalia said, adding that the economy was beginning bottom out.
Last September, Prime Minister Manmohan Singh’s fractious coalition ended a debilitating phase of policy inaction to make urgently needed reforms to reduce the fiscal deficit and attract foreign investment to help the current account deficit and growth.
The measures, which included giving foreign players more access to its retail and aviation sectors, helped India forestall the threat of a sovereign debt credit rating downgrade to junk status.
Recently, as part of an ongoing drive to trim spending, the government gave oil companies more room to set regulated diesel prices.
While steps taken by the government to bring the 2012/13 fiscal deficit within a targeted 5.3 percent of GDP have reduced near term risks, cuts in politically sensitive subsidies were needed for sustainable fiscal consolidation, the RBI said in an economic report issued a day before the policy review.
The current account deficit (CAD) touched a record high of 5.4 percent in July-September and is likely to rise further in the December quarter, according to the central bank’s economic report.
“Financing the CAD with increasingly risky and volatile flows increases the economy’s vulnerability to sudden shifts in risk appetite and liquidity preference, potentially threatening macroeconomic and exchange rate stability,” the RBI said.
For now though, India markets appeared content with the RBI’s measured easing. Benchmark government 10-year yields ended at 7.85 percent, down 1 bp from Monday. While the National Stock Exchange index, having struck a two-year high on Jan.6, fell to its lowest close in a week, ending 0.4 percent down, as did the bank sub-index.
The Indian rupee strengthened to 53.76/77 per dollar from its Monday close of 53.91/92.