RBI Cuts CRR and leaves Repo Rate Untouched

Today, The Reserve Bank of India (RBI) left interest rates unchanged but cut the cash reserve ratio for banks by 25 bps, saying the primary focus of monetary policy remains fighting inflation, days after the government unveiled a string of reforms to boost growth and improve its fiscal position.

The RBI left the policy repo rate at 8 percent. The RBI cut the cash reserve ratio (CRR), the share of deposits banks must keep with the central bank, by 25 basis points to 4.5 percent in a move it said will inject about 170 billion rupees of liquidity into the banking system.

The rupee and bond prices weakened immediately after the RBI decision, with the yield on the 10-year bond rising 5 basis points from before the RBI statement to 8.17 percent. The one-year swap rate rose 8 bps to 7.68 percent from before the release. The sensex and nifty have also seen some decline from their respective high after immediate RBI policy announcement.

"The government's recent actions have paved the way for a more favourable growth-inflation dynamic by initiating a shift in expenditure away from consumption (subsidies) and towards investment (including through FDI). However, in the current situation, persistent inflationary pressures alongside risks emerging from twin deficits-current account deficit and fiscal deficit -- constrain a stronger response of monetary policy to growth risks" the RBI wrote in its policy statement.

On Thursday, the government announced a sharp increase in the price of heavily subsidised diesel. It had unveiled a slate of measures to rein in a ballooning fiscal deficit and avoid a credit rating downgrade to junk. However, for common man it has become very difficult to run their daily life expenses and govt has its own target to control fiscal deficit devil.

The RBI has held borrowing costs steady since a deeper-than-expected 50 basis point cut in April, and has repeatedly called on the government to do its part by improving its fiscal position, which had fuelled some expectation that it might cut rates as a gesture in reply to the government's moves.

Govt’s diesel price hike decision had initially prompted market participants to speculate that the RBI may lower interest rates on Monday, but a spike in August inflation data on Friday from July's near three-year low put a damper on such expectations. India's wholesale price index rose a higher-than-expected 7.55 percent in August from a year earlier, mainly driven by higher food prices.
The govt seems serious about reform this time. The diesel price rise will aggravate short term inflation. But, along with the measures unveiled Friday to liberalise ownership of supermarkets and other industries, it shows the government is serious about fiscal consolidation and encouraging investment, and may make RBI more inclined to ease monetary policy sooner than later.

The government kicked into gear late last week after a wave of corruption scandals had weakened it and led to months of little substantive policy action, souring investor sentiment and putting at risk India's investment-grade credit rating.
So we can say, RBI has made a balancing act and kept an eye on inflation also. Now it is important how well and soon govt’s reform measures for growth would be implemented. There is also a strong fear that the announced measures may be stuck in opposition’s strong movement against these reform policies.

Regards,

Arvind Trivedi

Certified Financial Planner

arvind.trivedi79@gmail.com