Reserve Requirement Lowered in India

January 24, 2012

Monetary officials at the Reserve Bank of India cut their cash reserve requirement to 5.5% from 6.0% but left the key 7.5% reverse repo rate and 8.5% repo rate unchanged.  This combination of moves is expected to ease excessively tight liquidity conditions, mitigate a slowdown in growth, but also contain price pressures and anchor medium-term inflation expectations.  Officials would like to reduce interest rates but feel it would be premature to do so now. 

Based on the current inflation trajectory, including the fact that there is considerable suppressed inflation, it is premature to begin reducing the policy rate. The reduction in the policy rate will be conditioned by signs of a sustainable moderation in inflation. At the same time, the persistence of tight liquidity conditions could disrupt credit flow, and further exacerbate growth risks. In this context, the CRR is the most effective instrument for permanent liquidity injection over a sustained period of time. The CRR reduction can also be viewed as a reinforcement of the guidance that the interest rate cycle has peaked and that future rate actions will be towards lowering the policy interest rate.

Policy settings were left unchanged at the prior meeting in mid-December, breaking a streak of 13 rate hikes in a row, amounting to 200 basis points in 2010 beginning in March of that year and another 225 bps in 2011.  Today’s statement cut projected GDP growth in fiscal 2011-12 to 7.0% from an earlier forecast of 7.6%.  Despite this revision, forecasts of inflation were not reduced in part because prior rupee depreciation is feeding core inflation. The statement concludes with a plea to the government to tighten fiscal policy: "There is an urgent need for decisive fiscal consolidation, which will shift the balance of aggregate demand from public to private, and from consumption to capital formation. This is critical to yielding the space required for lowering rates without the imminent risk of resurgent inflation. The forthcoming Union Budget must exploit the opportunity to begin this process in a credible and sustainable way."

Copyright 2012, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.



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