Reserve Bank of India Reins in Some of its Unconventional Stimulus

October 27, 2009

Following a quarterly monetary policy review, central bank officials held key interest rates steady as expected but released a statement defending an earlier rather than later implementation of an exit strategy and announced some first pull-backs of unconventional liquidity provisions.  Unlike most economies, India faces accelerating inflation, which makes the Reserve Bank of India’s (RBI’s) circumstances different from those most central banks face.  Consumer prices rose 11.7% in the year to August, up from 9.0% a year earlier.  In July, monetary officials had raised projected WPI inflation in fiscal 2009-10 by a percentage point to 5%, and they lifted it further today to 6.5% with an upward bias.  The inflation is being driven by supply-side factors, particularly the worst drought in 37 years that is boosting food costs.  Today’s statement advises that it is “appropriate to sequence the exit in a calibrated way so that while the recovery process in not hampered, expected inflation remains anchored.”  In that spirit, officials

  • Restored the statutory liquidity ratio to 25% from 24% and
  • Discontinued two special refinancing facilities.

However, the central bank’s benchmark 4.75% repo interest rate and 3.25% reverse repo rate were not modified, nor was the 5.0% cash reserve ratio.  The key repo rate thus stays below inflation and 425 basis points lower than its pre-October 2008 peak of 9.0%.  Six reductions totaling 425 basis points were implemented from October 20, 2008 to April 21, 2009.  Three of these were moves of 100 basis points, two were by 50 basis points, and the final one six months ago was a cut of 25 basis points.  The statement that accompanied that final move suggested that further rate reductions were probable, but that has not been necessary.  RBI officials retained a forecast of 6.0% for GDP growth in fiscal 2009-10, with a bias toward a stronger figure.  GDP climbed 6.1% in the year to 2Q09 despite a continuing contraction of exports and the drought.  Industrial production in August was 10.4% greater than a year earlier.

Copyright Larry Greenberg 2009.  All rights reserved.  No secondary distribution without express permission.

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