RBI cuts rates and strikes dovish note for 2013

The Reserve Bank of India (RBI) today cut its headline interest rate 25 basis points to 7.75%, the first time in nine months that the rate has been reduced.

In a statement following the monetary policy meeting, governor Duvvuri Subbarao said three main considerations had informed the decision. Inflation in India, which remained stubbornly high for the majority of the last year, softened slightly in the third quarter of the fiscal year 2012–13, while growth "decelerated significantly". The RBI forecast growth in fiscal 2012–13 of 5.5%, down from a prediction of 6.5% in July 2012.

Liquidity conditions also remained tight, Subbarao said, despite the central bank cutting the cash reserve requirement from 6% to 4.25% last year, and knocking a further 25bp off today. "This tightness could potentially hurt credit flow to productive sectors of the economy," he said.

The governor hinted that more rate cuts could be made later in the year, as there was an "increasing likelihood" that inflation would remain moderate. "This provides space, albeit limited, for monetary policy to give greater emphasis to growth risks," he said.

Anubhuti Sahay, a senior economist for Standard Chartered in South Asia, says it is likely to be a dovish year for the central bank: "We do expect the RBI to reduce the repo rate further in 2013." Sahay predicted rates would fall as low as 7% by the end of the year.

Sahay also noted that the Indian government had "expressed its preference" for lower interest rates in the past, as it grapples with a budget deficit that is likely to hit 5.1% of GDP in fiscal 2012–13, or 5.1 trillion rupees ($95 billion), according to figures published by the Indian Finance Ministry on January 24.

Subbarao, who has pushed for government action in the past, called again for law-makers to tackle the structural problems afflicting the economy. "Critical to this effort are a credible and comprehensive fiscal adjustment by the government, implementation of structural reforms, hastening the approval process and improving governance," he said.

The Reserve Bank, he said, will have to calibrate its policy towards both the "evolving growth-inflation dynamic" and the "twin deficit risks" – budget and trade. India's current account deficit widened to 23.3% year-on-year in the third quarter of fiscal 2012–13.