RBI leaves policy rates unchanged on liquidity concerns

The Reserve Bank of India has decided to leave all policy rates unchanged despite rising inflation and high fiscal and trade deficits in the light of the delicate macroeconomic situation.

Raghuram RajanAccordingly, the policy repo rate under the liquidity adjustment facility (LAF) remains unchanged at 7.75 per cent and the reverse repo rate under the LAF will remain unchanged at 6.75 per cent.

The marginal standing facility (MSF) rate and the Bank Rate has also been kept unchanged at 8.75 per cent.

The cash reserve ratio (CRR) of scheduled banks remains at 4.0 per cent of net demand and time liability (NDTL).

This has been done in light of the persisting weakness in industrial activity that has been extended into the fiscal third quarter, still lacklustre lead indicators of service sector and subdued domestic consumption demand, all of which suggest continuing headwinds to growth, RBI said.

The pick-up in real GDP growth in Q2 of 2013-14, albeit modest, was driven largely by robust growth of agricultural activity, supported by an improvement in net exports, it added.

While the tapering of quantitative easing by the US Fed may disrupt external markets by limiting inflows of funds, RBI said it cannot soften its stand on inflation for obvious reasons.

Tightening government spending in the fourth quarter to meet budget projections will add to consumption and investment constraints, RBI said, adding that the revival of stalled investment, especially in the projects cleared by the cabinet committee on investment, will be critical in this context.

On rising prices, RBI said, the high inflation levels at both wholesale and retail levels risk entrenching inflation expectations at unacceptably elevated levels, posing a threat to growth and financial stability.

The high inflation levels, if persist, could lead to a resumption of high rural wage growth, with subsequent inflationary pressures, RBI said.

High and persistent inflation also increases the risks of exchange rate instability, it added.

Although banks had parked more funds with the RBI in the first two weeks of December and refrained from utilising the limits under the overnight LAF repo and export credit refinance, RBI had conducted an additional 14-day term repo of Rs10,000 crore starting mid-December to provide for extra liquidity needed for advance tax payments.

RBI also opened a refinance facility of Rs5,000 crore for the Small Industries Development Bank of India (SIDBI) in order to ensure adequate credit flow to the productive sectors of the economy.

The narrowing of the trade deficit since June through November, on positive export growth and contraction in both oil and non-oil imports, should bring the current account deficit (CAD) down to a more sustainable level for the year as a whole, RBI said, adding that robust inflows into the swap windows opened by the RBI during August-November have contributed significantly to rebuilding foreign exchange reserves thus covering possible external financing requirements and providing stability to the foreign exchange market.

Looking ahead, these favourable developments should help to build resilience to external shocks, it said.

With the normalisation of exceptional monetary measures, overall liquidity conditions have improved. Capital inflows under the RBI's swap facilities for banking capital and non-resident deposits augmented domestic liquidity significantly from the end of November, RBI noted.

The outlook for global growth continues to remain moderate, with an uneven recovery across industrial countries.

Activity in major emerging market economies barring China has decelerated on account of weak domestic demand, notwithstanding some improvement in export performance. While volatility in financial markets has receded, it could pick up again with the tapering of quantitative easing in the US, given the large dependence of EMEs on external financing, RBI added.