RBI Signals India Rate-Cut Limits as Policy Revamped: Economy

The Reserve Bank of India signaled elevated inflation is limiting room to cut interest rates even as its focus may shift to spurring growth as the government implements an overhaul of economic policies.

“The scope for supportive monetary policy action is constrained,” the Reserve Bank of India said in a report yesterday ahead of its interest-rate decision in Mumbai today. “However, as reform actions get executed, monetary policy could increasingly focus on growth revival.”

The central bank report suggests there are “clear risks” to Goldman Sachs Group Inc.’s expectations for a front-loading of rate cuts this month, economist Tushar Poddar said in a note yesterday. While the government has vowed to curb the budget gap to damp price pressures, costlier diesel and risks from a trade deficit will limit the central bank to a 25 basis-point rate cut, according to 30 of 35 analysts in a Bloomberg News survey.

“Going forward, the central bank’s actions are going to be based on the government’s ability to execute a credible deficit-cut plan,” said Shubhada Rao, Mumbai-based chief economist at Yes Bank Ltd. “Given the tone of the statement, aggressive easing from the central bank is highly unlikely.”

Rao forecasts Governor Duvvuri Subbarao will lower the repurchase rate to 7.75 percent from 8 percent. India’s inflation eased to a three-year low in December even as it remained the fastest in major emerging markets at 7.18 percent.

Prime Minister Manmohan Singh’s government has overhauled economic policies since mid-September to pare subsidies, lure more foreign investment and spur infrastructure projects.

Twin Deficits

Singh is trying to revive an economy expanding at the weakest pace in a decade and tame fiscal and current-account gaps that have increased the risk of a credit-rating downgrade.

The rupee, up about 2.7 percent since the policy changes began, weakened 0.4 percent to 53.915 a dollar at the 5 p.m. close in Mumbai yesterday. The BSE India Sensitive Index was little changed. The yield on the 8.15 percent bonds maturing in June 2022 dropped to 7.86 percent from 7.89 percent on Jan. 24.

“The balance of macroeconomic risks suggest continuation of the calibrated stance while increasingly focusing on growth risks,” the central bank said in the report. “Reforms since September 2012 have reduced immediate risks, but there is a long road ahead to bring about a sustainable turnaround for the Indian economy.”

Smaller Steps?

Aside from inflation, a record current-account deficit of $22.31 billion in the quarter ended Sept. 30, as well as the fiscal shortfall, are constraints on easing, it said. The government aims to narrow the budget gap to 5.3 percent of gross domestic product in the 12 months through March, from 5.8 percent.

The use of “calibrated” in the central bank’s comments suggests that the RBI may be more comfortable in easing in steps of 25 basis points rather than a front-loaded easing, said Poddar at Goldman Sachs.

“While we continue to expect a cumulative 50 basis points of easing in the first quarter, and indeed in calendar 2013, there are clear risks to our forecast of a 50 basis-point rate cut in the Jan. 29 policy meeting,” the economist said.

Moderating Inflation

The Reserve Bank said if inflation trends down, “monetary policy could increasingly shift focus” to aid expansion. While higher diesel tariffs may lead to price pressures, inflation may continue to moderate this quarter, it said.

Subbarao has kept the repurchase rate at 8 percent since a 50 basis-point cut in April last year. He has cut the cash reserve ratio four times since the start of 2012. The central bank signaled in December it may ease policy in coming months to aid growth.

The economy may expand 5.5 percent in the year through March 2013, based on a compilation of forecasts from other organizations, yesterday’s report showed. October’s projection was 5.7 percent. Inflation may average 7.5 percent, based on the compilation, compared with an earlier 7.7 percent estimate.

Subbarao will lower borrowing costs to 7.5 percent, four analysts said in the Bloomberg survey. One forecast no change.

“Even if inflation recedes further, the wide CAD may slow the pace and extent to which monetary policy can be eased,” the central bank said in yesterday’s report, referring to the current-account deficit.

Diesel Prices

India on Jan. 17 partially freed diesel prices from state control to curb fuel subsidies. A rise of 0.45 rupees a liter every month until March 2014 will add around 64 basis points to benchmark inflation, Nomura Holdings Inc. said.

The Finance Ministry forecasts economic growth of as little as 5.7 percent in 2012-2013, the least since 2002-2003. The expansion will reach 6.5 percent in 2013-2014, according to the median of 30 estimates in a Bloomberg News survey.

Elsewhere in Asia today, a government report showed New Zealand’s annual trade deficit unexpectedly narrowed in December as imports fell to an eight-month low. In Australia, a private report showed business confidence for December rebounded by the most since 2001 after the central bank’s sixth interest-rate cut in 14 months.

In Europe later today, reports may show retail sales in Spain declined in December from a year earlier, a French consumer confidence measure was unchanged from its December reading, and a German import price index may have fallen last month for the third time in the past four months, surveys of economists showed.

In the U.S., private reports may show home prices in November posted their biggest year-on-year advance since August 2006, while consumer confidence as measured by the New York-based Conference Board likely weakened in January for a third straight month, surveys showed.

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