Sept. 17 (Bloomberg) -- India’s central bank unexpectedly reduced the amount of deposits lenders must set aside as reserves, supporting the government’s push to revive growth even as it kept interest rates unchanged to damp elevated inflation.
Governor Duvvuri Subbarao cut the cash reserve ratio to 4.5 percent from 4.75 percent, effective Sept. 22, adding about 170 billion rupees ($3.1 billion) to the banking system, the Reserve Bank of India said today. Three of 39 economists in a Bloomberg News survey predicted the reduction to the lowest level since 2004. The rest forecast no change after two cuts earlier in 2012.
Inflation has quickened beyond 7.5 percent, a climb that may be exacerbated by the first increase in diesel prices in 14 months and a rise in commodities as the U.S. steps up monetary easing. India boosted the subsidized fuel’s tariff last week to pare its fiscal deficit and allowed more foreign investment in the economy, the biggest policy overhaul of Prime Minister Manmohan Singh’s previously gridlocked second term.
“It’s a token move to pat the government on the back but inflation is still going to go up due to domestic price adjustments and global factors,” said Rajeev Malik, a senior economist at CLSA Asia-Pacific Markets in Singapore. “Further actions by the RBI will depend on the fiscal correction and inflation dynamics.”
The rupee strengthened 0.6 percent to 54.0075 per dollar in Mumbai, while the BSE India Sensitive Index rose 0.42 percent. The yield on the 10-year bonds due June 2022 was little changed. The currency surged 2 percent on Sept. 14 on Singh’s steps to counter India’s weakest expansion in almost a decade and prevent a credit-rating downgrade.
The central bank kept the benchmark repurchase rate at 8 percent, it said in today’s statement in Mumbai, leaving it unchanged for a third meeting as expected by 35 of 39 economists a Bloomberg survey. Four forecast a reduction to 7.75 percent.
The “primary focus” remains the containment of price pressures, the Reserve Bank said. Inflation and India’s fiscal and current-account shortfalls constrain a stronger monetary policy response to growth risks, it said.
“The government’s recent actions have paved the way for a more favorable growth-inflation dynamic,” the central bank said. “Several challenges remain, one of which is persistent inflation. But, as policy actions to stimulate growth materialize, monetary policy will reinforce the positive impact of these actions while maintaining its focus on inflation management.”
The reserve-ratio cut is a “small but welcome” measure, Finance Minister Palaniappan Chidambaram said in New Delhi today. He said he’s confident the central bank’s review on Oct. 30 will be “far more supportive of growth” as the government is expected to make further policy changes and lay out a path to “fiscal correction.”
There could be a slight slippage in the fiscal deficit even as the government plans to stick to the borrowing schedule for the year through March 2013, Chidambaram said later in comments to Bloomberg TV India. Growth could range from 6.1 percent to 6.7 percent this year, he said.
The Reserve Bank’s decision comes after Asian nations such as the Philippines, Indonesia, Malaysia and South Korea held rates this month. Officials are evaluating the impact of the U.S. Federal Reserve’s decision on Sept. 13 to embark on a third round of bond purchases to boost growth and employment.
India’s moves last week to contain spending on diesel subsidies and boost foreign investment in industries from retailing to aviation followed a months-long policy logjam that dimmed the outlook for Asia’s third-largest economy.
The gridlock was caused in part by discord in Singh’s fractious ruling coalition over whether the policies should be implemented. Corruption allegations added to the gloom by paralyzing Parliament.
“The government has initiated big-ticket reforms,” said Jyoti Narasimhan, India economist at IHS Global Insight in Bangalore. “It will still need to do more to spur investment and economic growth, and of course not roll back any of these measures in the face of expected heavy political opposition.”
The Reserve Bank predicts Indian expansion will hold at a nine-year low of 6.5 percent in the fiscal year through March 2013 as investment moderates and Europe’s debt crisis weighs on global growth. Forecasters including Goldman Sachs Group Inc. and Citigroup Inc. expect a pace of less than 6 percent.
Subdued expansion has affected companies such as motorcycle manufacturers, with sales in an industry that includes Hero Motocorp Ltd. and Bajaj Auto Ltd. down 4.5 percent last month, the first fall since January 2009, according to the Society of Indian Automobile Manufacturers.
The central bank has previously flagged inflation risks from the longer-term drop in the rupee, the prospect of costlier food as a below-average monsoon crimps farm output and the budget deficit. The rupee is down 12.3 percent in the past year.
Subbarao lowered the repurchase rate by 0.5 percentage point in April to 8 percent, the first reduction since 2009. The Reserve Bank has said that move “frontloaded” a cut on the assumption the government will restrain the budget shortfall.
Diesel prices rose about 14 percent under last week’s effort to curb subsidies. The climb will add as much as 72 basis points to headline inflation, keeping it at an average of 7.5 percent to 8 percent until December, Morgan Stanley said. It was 7.55 percent last month.
Singh needs to limit subsidies to meet the goal of narrowing the budget deficit to 5.1 percent of gross domestic product in the fiscal year through March 2013, from 5.8 percent.
Standard & Poor’s and Fitch Ratings said earlier this year India’s budget and trade gaps imperil its investment-grade credit rating.
The reform measures appear credit positive even as they carry “considerable execution risks” due to opposition within the ruling Congress-led coalition and the recent track record of policy reversals, Fitch Ratings said in a statement today.
Moody’s Investors Service said in a statement the effect of reform measures outweigh any credit-positive benefits because they are too small or carry rollback risks.
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